UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
QUARTERLY PERIOD ENDED September 30, 2004

Commission File Number 0-2525

Huntington Bancshares Incorporated

     
Maryland   31-0724920
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

41 South High Street, Columbus, Ohio 43287

Registrant’s telephone number (614) 480-8300

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [X] No [  ]

There were 231,105,691 shares of Registrant’s without par value common stock outstanding on October 31, 2004.

 


Huntington Bancshares Incorporated

INDEX

         
Part I. Financial Information
       
Item 1. Financial Statements (Unaudited)
       
Condensed Consolidated Balance Sheets at September 30, 2004, December 31, 2003, and September 30, 2003
    3  
Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2004 and 2003
    4  
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2004 and 2003
    5  
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003
    6  
Notes to Unaudited Condensed Consolidated Financial Statements
    7  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
    19  
Item 3. Quantitative and Qualitative Disclosures about Market Risk
    77  
Item 4. Controls and Procedures
    77  
Part II. Other Information
       
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
    78  
Item 6. Exhibits and Reports on Form 8-K
    78  
Signatures
    80  
  Exhibit 10(A)
  Exhibit 10(B)
  Exhibit 31.1
  Exhibit 31.2
  Exhibit 32.1
  Exhibit 32.2

2


Part 1. Financial Information

Item 1. Financial Statements

Huntington Bancshares Incorporated

Condensed Consolidated Balance Sheets
                         
    September 30,   December 31,   September 30,
(in thousands, except number of shares)
  2004
  2003
  2003
    (Unaudited)           (Unaudited)
Assets
                       
Cash and due from banks
  $ 1,053,358     $ 899,689     $ 775,423  
Federal funds sold and securities purchased under resale agreements
    838,833       96,814       87,196  
Interest bearing deposits in banks
    36,155       33,627       37,857  
Trading account securities
    120,334       7,589       415  
Loans held for sale
    205,913       226,729       411,792  
Investment securities
    4,150,044       4,929,060       4,283,475  
Loans and leases
    22,587,259       21,075,118       21,172,747  
Allowance for loan and lease losses
    (282,650 )     (299,732 )     (336,398 )
 
   
 
     
 
     
 
 
Net loans and leases
    22,304,609       20,775,386       20,836,349  
 
   
 
     
 
     
 
 
Operating lease assets
    717,411       1,260,440       1,454,590  
Bank owned life insurance
    954,911       927,671       917,261  
Premises and equipment
    356,438       349,712       338,863  
Goodwill and other intangible assets
    216,011       217,009       217,212  
Customers’ acceptance liability
    8,787       9,553       9,208  
Accrued income and other assets
    844,689       786,047       759,282  
 
   
 
     
 
     
 
 
Total Assets
  $ 31,807,493     $ 30,519,326     $ 30,128,923  
 
   
 
     
 
     
 
 
Liabilities
                       
Deposits
  $ 20,109,025     $ 18,487,395     $ 18,833,856  
Short-term borrowings
    1,215,887       1,452,304       1,400,047  
Federal Home Loan Bank advances
    1,270,454       1,273,000       1,273,000  
Other long-term debt
    4,094,185       4,544,509       4,269,288  
Subordinated notes
    1,040,901       990,470       791,045  
Allowance for unfunded loan commitments and letters of credit
    30,007       35,522       33,737  
Bank acceptances outstanding
    8,787       9,553       9,208  
Accrued expenses and other liabilities
    1,577,330       1,451,571       1,277,286  
 
   
 
     
 
     
 
 
Total Liabilities
    29,346,576       28,244,324       27,887,467  
 
   
 
     
 
     
 
 
Shareholders’ Equity
                       
Preferred stock — authorized 6,617,808 shares; none outstanding
                 
Common stock — without par value; authorized 500,000,000 shares; issued 257,866,255 shares; outstanding 230,153,486; 229,008,088 and 228,869,936 shares, respectively
    2,482,904       2,483,542       2,482,370  
Less 27,712,769; 28,858,167 and 28,996,319 treasury shares, respectively
    (526,967 )     (548,576 )     (550,766 )
Accumulated other comprehensive income (loss)
    (13,812 )     2,678       25,865  
Retained earnings
    518,792       337,358       283,987  
 
   
 
     
 
     
 
 
Total Shareholders’ Equity
    2,460,917       2,275,002       2,241,456  
 
   
 
     
 
     
 
 
Total Liabilities and Shareholders’ Equity
  $ 31,807,493     $ 30,519,326     $ 30,128,923  
 
   
 
     
 
     
 
 

See notes to unaudited condensed consolidated financial statements

3


 

 
 

Huntington Bancshares Incorporated

Condensed Consolidated Statements of Income
(Unaudited)

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
(in thousands, except per share amounts)
  2004
  2003
  2004
  2003
Interest and fee income
                               
Loans and leases
                               
Taxable
  $ 284,790     $ 277,906     $ 823,562     $ 813,845  
Tax-exempt
    474       588       1,423       1,997  
Securities
                               
Taxable
    38,987       36,311       127,059       110,450  
Tax-exempt
    7,032       6,199       21,792       16,171  
Other
    6,719       12,316       14,264       28,196  
 
   
 
     
 
     
 
     
 
 
Total Interest Income
    338,002       333,320       988,100       970,659  
 
   
 
     
 
     
 
     
 
 
Interest expenses
                               
Deposits
    64,812       67,565       183,810       223,658  
Short-term borrowings
    3,121       2,992       9,222       12,864  
Federal Home Loan Bank advances
    8,426       5,883       24,565       17,102  
Subordinated notes and other long-term debt including preferred capital securities
    34,585       36,409       98,197       92,364  
 
   
 
     
 
     
 
     
 
 
Total Interest Expense
    110,944       112,849       315,794       345,988  
 
   
 
     
 
     
 
     
 
 
Net Interest Income
    227,058       220,471       672,306       624,671  
Provision for credit losses
    11,785       51,615       42,408       137,652  
 
   
 
     
 
     
 
     
 
 
Net Interest Income After Provision for Credit Losses
    215,273       168,856       629,898       487,019  
 
   
 
     
 
     
 
     
 
 
Operating lease income
    64,412       117,624       231,985       384,391  
Service charges on deposit accounts
    43,935       42,294       129,368       123,077  
Trust services
    17,064       15,365       50,095       45,856  
Brokerage and insurance income
    13,200       13,807       41,920       43,500  
Mortgage banking
    4,448       30,193       23,474       48,503  
Bank owned life insurance income
    10,019       10,438       31,813       32,618  
Other service charges and fees
    10,799       10,499       30,957       32,209  
Gain on sales of automobile loans
    312             14,206       23,751  
Gain on sale of branch offices
          13,112             13,112  
Securities gains (losses)
    7,803       (4,107 )     13,663       3,978  
Other
    17,899       23,543       68,177       71,648  
 
   
 
     
 
     
 
     
 
 
Total Non-Interest Income
    189,891       272,768       635,658       822,643  
 
   
 
     
 
     
 
     
 
 
Personnel costs
    121,729       113,170       363,068       331,501  
Operating lease expense
    54,885       93,134       188,158       307,661  
Outside data processing and other services
    17,527       17,478       53,552       50,161  
Equipment
    15,295       16,328       47,609       49,081  
Net occupancy
    16,838       15,570       49,859       47,556  
Professional services
    12,219       11,116       27,354       30,273  
Marketing
    5,000       5,515       20,908       20,595  
Telecommunications
    5,359       5,612       15,191       16,707  
Printing and supplies
    3,201       3,658       9,315       9,592  
Amortization of intangibles
    204       204       612       612  
Restructuring reserve releases
    (1,151 )           (1,151 )     (6,315 )
Other
    22,317       18,397       66,755       55,270  
 
   
 
     
 
     
 
     
 
 
Total Non-Interest Expense
    273,423       300,182       841,230       912,694  
 
   
 
     
 
     
 
     
 
 
Income Before Income Taxes
    131,741       141,442       424,326       396,968  
Provision for income taxes
    38,255       37,230       116,540       104,536  
 
   
 
     
 
     
 
     
 
 
Income before cumulative effect of change in accounting principle
    93,486       104,212       307,786       292,432  
Cumulative effect of change in accounting principle, net of tax
          (13,330 )           (13,330 )
 
   
 
     
 
     
 
     
 
 
Net Income
  $ 93,486     $ 90,882     $ 307,786     $ 279,102  
 
   
 
     
 
     
 
     
 
 
Average common shares — diluted
    234,348       230,966       233,307       231,353  
Per Common Share:
                               
Income before cumulative effect of change in accounting principle — Diluted
  $ 0.40     $ 0.45     $ 1.32     $ 1.26  
Net Income — Diluted
    0.40       0.39       1.32       1.21  
Cash Dividends Declared
    0.200       0.175       0.550       0.495  

See notes to unaudited condensed consolidated financial statements

4


 

Huntington Bancshares Incorporated

Condensed Consolidated Statements of Changes in Shareholders’ Equity

                                                         
                                    Accumulated        
    Common Stock
  Treasury Shares
  Other
Comprehensive
  Retained    
(in thousands)
  Shares
  Amount
  Shares
  Amount
  Income
  Earnings
  Total
Nine Months Ended September 30, 2003 (Unaudited) :
                                                       
Balance, beginning of period
    257,866     $ 2,484,421       (24,987 )   $ (475,399 )   $ 62,300     $ 118,471     $ 2,189,793  
Comprehensive Income:
                                                       
Net income
                                            279,102       279,102  
Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income
                                    (26,233 )             (26,233 )
Unrealized losses on derivative instruments used in cash flow hedging relationships
                                    (10,202 )             (10,202 )
 
                                                   
 
 
Total comprehensive income
                                                    242,667  
 
                                                   
 
 
Cash dividends declared ($0.495 per share)
                                            (113,586 )     (113,586 )
Stock options exercised
            (2,144 )     337       6,373                       4,229  
Treasury shares purchased
                    (4,300 )     (81,061 )                     (81,061 )
Other
            93       (46 )     (679 )                     (586 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, end of period ( Unaudited )
    257,866     $ 2,482,370       (28,996 )   $ (550,766 )   $ 25,865     $ 283,987     $ 2,241,456  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Nine Months Ended September 30, 2004 (Unaudited) :
                                                       
Balance, beginning of period
    257,866     $ 2,483,542       (28,858 )   $ (548,576 )   $ 2,678     $ 337,358     $ 2,275,002  
Comprehensive Income:
                                                       
Net income
                                            307,786       307,786  
Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income
                                    (19,555 )             (19,555 )
Unrealized gains on derivative instruments used in cash flow hedging relationships
                                    3,065               3,065  
 
                                                   
 
 
Total comprehensive income
                                                    291,296  
 
                                                   
 
 
Cash dividends declared ($0.550 per share)
                                            (126,352 )     (126,352 )
Stock options exercised
            (564 )     985       18,865                       18,301  
Other
            (74 )     160       2,744                       2,670  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, end of period ( Unaudited )
    257,866     $ 2,482,904       (27,713 )   $ (526,967 )   $ (13,812 )   $ 518,792     $ 2,460,917  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 

See notes to unaudited consolidated financial statements.

5


 

Huntington Bancshares Incorporated

Condensed Consolidated Statements of Cash Flows
(Unaudited)

                 
    Nine Months Ended
    September 30,
(in thousands)
  2004
  2003
Operating Activities
               
Net Income
  $ 307,786     $ 279,102  
Adjustments to reconcile net income to net cash provided by operating activities
               
Cumulative effect of change in accounting principle, net of tax
          13,330  
Provision for credit losses
    42,408       137,652  
Depreciation on operating lease assets
    187,022       290,474  
Other depreciation and amortization
    65,279       73,855  
Deferred income tax expense
    83,140       78,754  
Increase in trading account securities
    (112,745 )     (174 )
Decrease in loans held for sale
    20,566       116,587  
Gains on sales of investment securities
    (13,663 )     (3,978 )
Gains on sale of automobile loans
    (14,206 )     (23,751 )
Gains on sale of branch offices
          (13,112 )
Restructuring reserve releases
    (1,151 )     (6,315 )
Other, net
    (40,099 )     (155,245 )
 
   
 
     
 
 
Net Cash Provided by Operating Activities
    524,337       787,179  
 
   
 
     
 
 
Investing Activities
               
Increase in interest bearing deposits in banks
    (2,528 )     (557 )
Proceeds from:
               
Maturities and calls of investment securities
    746,386       1,343,838  
Sales of investment securities
    1,655,459       887,936  
Purchases of investment securities
    (1,530,657 )     (3,140,336 )
Proceeds from sales/securitizations of loans
    1,534,395       1,475,948  
Net loan and lease originations, excluding sales
    (3,216,666 )     (3,457,605 )
Net decrease in operating lease assets
    357,184       473,727  
Sale of branch offices
          (81,367 )
Proceeds from sale of premises and equipment
    340       6,825  
Purchases of premises and equipment
    (43,924 )     (44,076 )
Proceeds from sales of other real estate
    9,800       6,997  
Consolidation of cash of securitization trust
          58,500  
 
   
 
     
 
 
Net Cash Used for Investing Activities
    (490,211 )     (2,470,170 )
 
   
 
     
 
 
Financing Activities
               
Increase in total deposits
    1,610,167       1,525,808  
Decrease in short-term borrowings
    (236,417 )     (740,969 )
Proceeds from issuance of subordinated notes
    148,830        
Maturity of subordinated notes
    (100,000 )     (250,000 )
Proceeds from Federal Home Loan Bank advances
    454       270,000  
Maturity of Federal Home Loan Bank advances
    (3,000 )     (10,000 )
Proceeds from long-term debt
    675,000       1,450,000  
Maturity of long-term debt
    (1,130,000 )     (530,000 )
Dividends paid on common stock
    (121,773 )     (111,007 )
Repurchases of common stock
          (81,061 )
Net proceeds from issuance of common stock
    18,301       4,076  
 
   
 
     
 
 
Net Cash Provided by Financing Activities
    861,562       1,526,847  
 
   
 
     
 
 
Change in Cash and Cash Equivalents
    895,688       (156,144 )
Cash and Cash Equivalents at Beginning of Period
    996,503       1,018,763  
 
   
 
     
 
 
Cash and Cash Equivalents at End of Period
  $ 1,892,191     $ 862,619  
 
   
 
     
 
 
Supplemental disclosures:
               
Income taxes paid
  $ 14,031     $ 70,953  
Interest paid
    302,801       354,071  
Non-cash activities
               
Residential mortgage loans securitized and retained in securities available for sale
    115,929       171,586  
Common stock dividends accrued not paid
    36,254       30,901  

See notes to unaudited condensed consolidated financial statements.

6


 

Notes to Unaudited Condensed Consolidated Financial Statements

Note 1 – Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of Huntington Bancshares Incorporated (Huntington) reflect all adjustments consisting of normal recurring accruals, which are, in the opinion of Management, necessary for a fair presentation of the consolidated financial position, the results of operations, and cash flows for the periods presented. These unaudited condensed consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been omitted. The Notes to the Consolidated Financial Statements appearing in Huntington’s 2003 Annual Report on Form 10-K (2003 Form 10-K), which include descriptions of significant accounting policies, as updated by the information contained in this report, should be read in conjunction with these interim financial statements.

     Certain amounts in the prior year’s financial statements have been reclassified to conform to the 2004 presentation.

     For statement of cash flows purposes, cash and cash equivalents are defined as the sum of “Cash and due from banks” and “Federal funds sold and securities purchased under resale agreements.” The statement of cash flows for the nine-months ended September 30, 2003, has been corrected to properly reflect the sale of branch offices during the third quarter of 2003.

Note 2 – New Accounting Pronouncements

Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments (EITF 03-1): The Emerging Issues Task Force reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. EITF 03-1 also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. On September 30, 2004, the FASB issued FSP 03-1-1 which delayed the effective date for the measurement and recognition guidance contained in paragraphs 10–20 of Issue 03-1 due to additional proposed guidance expected to be finalized in the fourth quarter of 2004.

     At September 30, 2004, Huntington had $2.5 billion of debt securities with current market values less than their amortized cost. These debt securities had an aggregate unrealized loss of $32.7 million at September 30, 2004. None of these securities were equity securities or debt securities that can contractually be prepaid or otherwise settled in such a way that Huntington would not recover substantially all of its cost. At September 30, 2004, a total of $26.8 million of these debt securities had market values that were 5% or more below their amortized cost. The aggregate unrealized loss for these securities was $1.5 million. The declines in value are the result of interest rate fluctuations and Huntington believes the declines are temporary; therefore, no impairment loss has been recorded except as described in the paragraph below. Until the final FSP 03-1-1 is finalized, Huntington cannot determine the impact that the proposed guidance might have on the financial statements.

     At September 30, 2004, Management made a decision, to sell $11 million of equity securities, with unrealized losses of $0.9 million. Consequently, Huntington recognized the unrealized losses in the third quarter of 2004.

Emerging Issues Task Force Issue No. 03-16, Accounting for Investment in Limited Liability Companies (EITF 03-16): The Task Force reached a consensus that an investment in a limited liability company (LLC) that maintains a “specific ownership account” for each investor should be viewed as similar to an investment in a limited partnership for purposes of determining whether a noncontrolling investment in a LLC should be accounted for using the cost method or the equity method. The current rules require a noncontrolling investment in a limited partnership to be accounted for under the equity method unless the interest is so minor that the limited partner may have virtually no influence over the partnership operating and financial policies. The guidance for evaluating an investment in a LLC should be applied for reporting periods beginning after June 15, 2004. The impact of EITF 03-16 was not material to Huntington’s financial condition, results of operations, or cash flows.

SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments (SAB 105): On March 9, 2004, the SEC issued SAB 105, which summarizes the views of the SEC staff regarding the application of

7


generally accepted accounting principles to loan commitments accounted for as derivative instruments. Specifically, SAB 105 indicated that the fair value of loan commitments that are required to follow derivative accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities , should not consider the expected future cash flows related to the associated servicing of the future loan. Prior to SAB 105, Huntington did not consider the expected future cash flows related to the associated servicing in determining the fair value of loan commitments. The adoption of SAB 105 did not have a material effect on Huntington’s financial results.

FASB Staff Position No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-2): In December 2003, a law was approved that expands Medicare benefits, primarily adding a prescription drug benefit for Medicare-eligible retirees beginning in 2006. The law also provides a federal subsidy to companies that sponsor postretirement benefit plans providing prescription drug coverage. FSP 106-2 was issued in May 2004 and supersedes FSP 106-1 issued in January 2004. FSP 106-2 specifies that any Medicare subsidy must be taken into account in measuring the employer’s postretirement health care benefit obligation and will also reduce the net periodic postretirement cost in future periods. The new guidance is effective for the reporting periods beginning on or after June 15, 2004. The impact of this new pronouncement was not material to Huntington’s financial condition, results of operations, or cash flows.

AICPA Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3): In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 03-3 to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities purchased or acquired in purchase business combinations and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

Note 3 – Securities and Exchange Commission Investigation

     As previously disclosed, Huntington continues to have ongoing discussions with the staff of the Securities and Exchange Commission (SEC) regarding resolution of its formal investigation into certain financial accounting matters relating to fiscal years 2002 and earlier and certain related disclosure matters. It is anticipated that a settlement of this matter will involve the entry of an order by the SEC requiring Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a civil money penalty. No assurances, however, can be provided as to the ultimate timing or outcome of this matter pending a final settlement.

Note 4 – Formal Supervisory Agreements and Impact on Pending Acquisition

     On November 3, 2004, Huntington announced that it expects to enter into formal supervisory agreements with its banking regulators, the Federal Reserve and the Office of the Controller of the Currency, providing for a comprehensive action plan designed to address its financial reporting and accounting policies, procedures, and controls and its corporate governance practices. Huntington remains in active dialogue with banking regulators concerning these and related matters and is working diligently to resolve this in a full and comprehensive manner.

     On January 27, 2004, Huntington announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio, with $2.7 billion of assets at December 31, 2003. Under the terms of the agreement, Unizan shareholders would receive 1.1424 shares of Huntington common stock, on a tax-free basis, for each share of Unizan.

8


     As part of its November 3, 2004, announcement, Huntington indicated that it is negotiating a one-year extension of its merger agreement with Unizan. Huntington intends to withdraw its current application with the Federal Reserve to acquire Unizan and to resubmit the application for regulatory approval of the merger once it has successfully resolved the aforementioned regulatory concerns.

     Huntington believes that it will be able to address all of the issues that have been raised by its banking regulators and the SEC (see Note 3) concerning these matters in a comprehensive manner and is working aggressively to do so. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

Note 5 – Stock Repurchase Plan

     Effective April 27, 2004, the board of directors authorized a new share repurchase program (the 2004 Repurchase Program) which cancelled the 2003 Repurchase Program and authorized Management to repurchase not more than 7,500,000 shares of Huntington common stock. Purchases will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions. As of September 30, 2004, there have been no  
share repurchases made under the 2004 Repurchase Program.

Note 6 – Operating Lease Assets

     Operating lease assets at September 30, 2004, December 31, 2003, and September 30, 2003, were as follows:

                         
    September 30,   December 31,   September 30,
(in thousands)
  2004
  2003
  2003
Cost of assets under operating leases
  $ 1,368,787     $ 2,136,502     $ 2,416,907  
Deferred lease origination fees and costs
    (939 )     (2,117 )     (40,220 )
Accumulated depreciation
    (650,437 )     (873,945 )     (922,097 )
 
   
 
     
 
     
 
 
Operating Lease Assets, Net
  $ 717,411     $ 1,260,440     $ 1,454,590  
 
   
 
     
 
     
 
 

     Depreciation related to operating lease assets was $54.6 million and $86.5 million for the three months ended September 30, 2004 and 2003, respectively. For the respective nine-month periods, depreciation was $187.0 million and $290.5 million.

9


 

Note 7 – Investment Securities

     Listed below are the contractual maturities (under 1 year, 1-5 years, 6-10 years and over 10 years) of investment securities at September 30, 2004, December 31, 2003, and September 30, 2003:

                                                 
    September 30, 2004
  December 31, 2003
  September 30, 2003
    Amortized           Amortized           Amortized    
(in thousands of dollars)
  Cost
  Fair Value
  Cost
  Fair Value
  Cost
  Fair Value
U.S. Treasury
                                               
Under 1 year
  $     $     $ 1,374     $ 1,376     $ 325     $ 329  
1-5 years
    24,230       24,551       31,356       31,454       32,855       33,611  
6-10 years
    754       842       271,271       275,540       270,529       281,343  
Over 10 years
                                   
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total U.S. Treasury
    24,984       25,393       304,001       308,370       303,709       315,283  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Federal Agencies
                                               
Mortgage-backed securities
                                               
1-5 years
    2,773       2,831       19,899       20,434       21,289       21,931  
6-10 years
    100,827       101,157       198,755       201,995       235,180       239,766  
Over 10 years
    939,050       929,892       1,593,139       1,595,594       1,594,938       1,607,969  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Mortgage-Backed
    1,042,650       1,033,880       1,811,793       1,818,023       1,851,407       1,869,666  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Other Agencies
                                               
Under 1 year
    499       510       173,181       175,505       193,091       197,357  
1-5 years
    564,302       562,705       585,561       593,662       389,418       403,841  
6-10 years
    317,312       307,070       403,953       390,164       404,776       398,626  
Over 10 years
                201       192              
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Other Agencies
    882,113       870,285       1,162,896       1,159,523       987,285       999,824  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total U.S Treasury and Federal Agencies
    1,949,747       1,929,558       3,278,690       3,285,916       3,142,401       3,184,773  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Municipal Securities
                                               
Under 1 year
    7,180       7,199       7,989       8,058       8,345       8,414  
1-5 years
    9,396       9,596       21,706       22,260       27,056       27,804  
6-10 years
    86,677       87,788       70,253       71,755       46,521       47,408  
Over 10 years
    293,322       297,519       332,181       334,188       316,469       316,552  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Municipal Securities
    396,575       402,102       432,129       436,261       398,391       400,178  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Private Label CMO
                                               
Under 1 year
                1,973       1,973              
1-5 years
                                   
6-10 years
                                   
Over 10 years
    564,084       560,563       388,933       388,684       192,869       193,149  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Private Label CMO
    564,084       560,563       390,906       390,657       192,869       193,149  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Asset Backed Securities
                                               
Under 1 year
                                   
1-5 years
    30,000       29,944       30,000       29,944       30,000       29,944  
6-10 years
    9,725       9,838       20,000       19,984       20,000       19,839  
Over 10 years
    1,051,982       1,053,020       590,826       589,788       278,498       277,977  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Asset Backed Securities
    1,091,707       1,092,802       640,826       639,716       328,498       327,760  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Other
                                               
Under 1 year
    1,601       1,612       500       502       1,490       1,497  
1-5 years
    9,612       9,968       7,169       7,346       9,327       9,772  
6-10 years
    2,253       2,351       5,047       5,510       4,045       4,422  
Over 10 years
    144,201       144,707       145,103       146,685       141,901       143,436  
Retained interest in securitizations
                5,593       6,356       5,671       5,960  
Marketable equity securities
    5,965       6,381       8,547       10,111       11,529       12,528  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Other
    163,632       165,019       171,959       176,510       173,963       177,615  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Investment Securities
  $ 4,165,745     $ 4,150,044     $ 4,914,510     $ 4,929,060     $ 4,236,122     $ 4,283,475  
 
   
 
     
 
     
 
     
 
     
 
     
 
 

10


     The growth in the Asset Backed Securities from year-end and the year-ago quarter primarily consisted of over 10-year variable-rate securities.

Note 8 – Segment Reporting

     Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes the company’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Lines of business results are determined based upon the company’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around Huntington’s organizational and management structure and, accordingly, the results below are not necessarily comparable with similar information published by other financial institutions. A description of each segment and discussion of financial results is provided below.

Regional Banking: This segment provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 59% and 80% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank—Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.

Dealer Sales: This segment serves over 3,500 automotive dealerships within Huntington’s primary banking markets as well as in Arizona, Florida, Georgia, Pennsylvania, and Tennessee. The segment finances the purchase of automobiles by consumers of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct financing leases to consumers, finances dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the automotive dealerships and their owners.

Private Financial Group: This segment provides products and services designed to meet the needs of the company’s higher net worth customers. Revenue is derived through trust, asset management, investment advisory, brokerage, insurance, and private banking products and services.

Treasury/Other: This segment includes revenue and expense related to assets, liabilities, and equity that are not directly assigned or allocated to one of the other three business segments. Assets included in this segment include investment securities, bank owned life insurance, and mezzanine loans originated through Huntington Capital Markets. A match-funded transfer pricing system is used to attribute appropriate interest income and interest expense to other business segments. This segment includes the net impact of interest rate risk management, including derivative activities. Furthermore, this segment’s results include the earnings from the company’s investment securities portfolios and capital markets activities. Additionally, income or expense and provision for income taxes, not allocated to other business segments, are also included.

Use of Operating Earnings to Measure Segment Performance

     Management uses earnings on an operating basis, rather than on a GAAP basis, to measure underlying performance trends for each business segment. Analyzing earnings on an operating basis is very helpful in assessing underlying performance trends, a critical factor used by Management to determine the success of strategies and future earnings capabilities. Operating earnings represent GAAP earnings adjusted to exclude the impact of the significant items listed in the reconciliation table below. See Note 12 for further discussions regarding Restructuring Reserves.

11


     Listed below is certain reported financial information reconciled to Huntington’s three and nine month 2004 and 2003 operating results by line of business.

 
                                         
    Three Months Ended September 30,
Income Statements   Regional   Dealer           Treasury/   Huntington
(in thousands)
  Banking
  Sales
  PFG
  Other
  Consolidated
2004
                                       
Net interest income
  $ 163,147     $ 37,376     $ 11,715     $ 14,820     $ 227,058  
Provision for credit losses
    (5,086 )     (6,100 )     (72 )     (527 )     (11,785 )
Non-Interest income
    77,256       73,145       27,588       11,902       189,891  
Non-Interest expense
    (144,423 )     (77,149 )     (27,083 )     (24,768 )     (273,423 )
Provision for income taxes
    (31,813 )     (9,545 )     (4,252 )     7,355       (38,255 )
 
   
 
     
 
     
 
     
 
     
 
 
Net income, as reported
    59,081       17,727       7,896       8,782       93,486  
Gain on sale of automobile loans, net of tax
          (384 )           181       (203 )
Restructuring releases, net of taxes
                      (748 )     (748 )
 
   
 
     
 
     
 
     
 
     
 
 
Operating Earnings
  $ 59,081     $ 17,343     $ 7,896     $ 8,215     $ 92,535  
 
   
 
     
 
     
 
     
 
     
 
 
2003
                                       
Net interest income
  $ 160,973     $ 29,236     $ 11,085     $ 19,177     $ 220,471  
Provision for credit losses
    (32,537 )     (16,036 )     (2,415 )     (627 )     (51,615 )
Non-Interest income
    97,772       125,536       25,815       23,645       272,768  
Non-Interest expense
    (141,422 )     (115,006 )     (26,092 )     (17,662 )     (300,182 )
Provision for income taxes
    (29,675 )     (8,306 )     (2,938 )     3,689       (37,230 )
 
   
 
     
 
     
 
     
 
     
 
 
Income before cumulative effect of change in accounting principle
    55,111       15,424       5,455       28,222       104,212  
Cumulative effect of change in accounting principle, net of tax
          (10,888 )           (2,442 )     (13,330 )
 
   
 
     
 
     
 
     
 
     
 
 
Net income, as reported
    55,111       4,536       5,455       25,780       90,882  
Cumulative effect of change in accounting principle, net of tax
          10,888             2,442       13,330  
Gain on sale of branch offices, net of tax
                      (8,523 )     (8,523 )
 
   
 
     
 
     
 
     
 
     
 
 
Operating Earnings
  $ 55,111     $ 15,424     $ 5,455     $ 19,699     $ 95,689  
 
   
 
     
 
     
 
     
 
     
 
 

12


                                         
     
Nine Months Ended September 30,
Income Statements   Regional   Dealer           Treasury/   Huntington
(in thousands)
  Banking
  Sales
  PFG
  Other
  Consolidated
2004
                                       
Net interest income
  $ 469,292     $ 111,267     $ 34,010     $ 57,737     $ 672,306  
Provision for credit losses
    (3,242 )     (36,016 )     (169 )     (2,981 )     (42,408 )
Non-Interest income
    231,782       269,683       83,895       50,298       635,658  
Non-Interest expense
    (439,515 )     (254,286 )     (85,103 )     (62,326 )     (841,230 )
Provision for income taxes
    (90,411 )     (31,727 )     (11,422 )     17,020       (116,540 )
 
   
 
     
 
     
 
     
 
     
 
 
Net income, as reported
    167,906       58,921       21,211       59,748       307,786  
Gain on sale of automobile loans, net of tax
          (8,598 )           (636 )     (9,234 )
Restructuring releases, net of taxes
                      (748 )     (748 )
 
   
 
     
 
     
 
     
 
     
 
 
Operating Earnings
  $ 167,906     $ 50,323     $ 21,211     $ 58,364     $ 297,804  
 
   
 
     
 
     
 
     
 
     
 
 
2003
                                       
Net interest income
  $ 457,805     $ 56,522     $ 30,365     $ 79,979     $ 624,671  
Provision for credit losses
    (96,615 )     (36,612 )     (3,858 )     (567 )     (137,652 )
Non-Interest income
    241,161       437,355       80,878       63,249       822,643  
Non-Interest expense
    (425,045 )     (374,639 )     (78,613 )     (34,397 )     (912,694 )
Provision for income taxes
    (62,057 )     (28,920 )     (10,071 )     (3,488 )     (104,536 )
 
   
 
     
 
     
 
     
 
     
 
 
Income before cumulative effect of change in accounting principle
115,249 53,706 18,701 104,776 292,432
Cumulative effect of change in accounting principle, net of tax
(10,888 ) (2,442 ) (13,330 )
 
   
 
     
 
     
 
     
 
     
 
 
Net income, as reported
    115,249       42,818       18,701       102,334       279,102  
Cumulative effect of change in accounting principle, net of tax
10,888 2,442 13,330
Gain on sale of automobile loans, net of tax
(4,807 ) (10,631 ) (15,438 )
Gain on sale of branch offices, net of tax
                    (8,523 )     (8,523 )
Restructuring releases, net of taxes
                      (4,105 )     (4,105 )
 
   
 
     
 
     
 
     
 
     
 
 
Operating Earnings
  $ 115,249     $ 48,899     $ 18,701     $ 81,517     $ 264,366  
 
   
 
     
 
     
 
     
 
     
 
 
                                                 
     
Total Assets at
  Total Deposits at
Period-end Balance Sheet Data   September 30,   December 31,   September 30,   September 30,   December 31,   September 30,
(in millions)
  2004
  2003
  2003
  2004
  2003
  2003
Regional Banking
  $ 17,199     $ 14,971     $ 14,974     $ 16,931     $ 15,539     $ 15,671  
Dealer Sales
    5,957       7,335       7,859       70       77       66  
PFG
    1,558       1,461       1,421       1,125       1,164       1,118  
Treasury / Other
    7,093       6,752       5,875       1,983       1,707       1,979  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total
  $ 31,807     $ 30,519     $ 30,129     $ 20,109     $ 18,487     $ 18,834  
 
   
 
     
 
     
 
     
 
     
 
     
 
 

13


 

Note 9 – Comprehensive Income

     The components of Huntington’s Other Comprehensive Income in the three and nine months ended September 30 were as follows:

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
(in thousands)
  2004
  2003
  2004
  2003
Unrealized holding (losses) gains on securities available for sale arising during the period:
                               
Unrealized net gains (losses)
  $ 58,167     $ (37,796 )   $ (16,588 )   $ (35,997 )
Related tax (expense) benefit
    (20,484 )     13,284       5,914       12,350  
 
   
 
     
 
     
 
     
 
 
Net
    37,683       (24,512 )     (10,674 )     (23,647 )
 
   
 
     
 
     
 
     
 
 
Less: Reclassification adjustment for net gains (losses) included in net income
                               
Realized net gains (losses)
    7,803       (4,107 )     13,663       3,978  
Related tax (expense) benefit
    (2,731 )     1,437       (4,782 )     (1,392 )
 
   
 
     
 
     
 
     
 
 
Net
    5,072       (2,670 )     8,881       2,586  
 
   
 
     
 
     
 
     
 
 
Total unrealized holding gains (losses) on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income
    32,611       (21,842 )     (19,555 )     (26,233 )
 
   
 
     
 
     
 
     
 
 
Unrealized (losses) gains on derivatives used in cash flow hedging relationships arising during the period:
                               
Unrealized net (losses) gains
    (29,568 )     10,600       4,715       (15,695 )
Related tax benefit (expense)
    10,349       (3,710 )     (1,650 )     5,493  
 
   
 
     
 
     
 
     
 
 
Net
    (19,219 )     6,890       3,065       (10,202 )
 
   
 
     
 
     
 
     
 
 
Total Other Comprehensive Income (Loss)
  $ 13,392     $ (14,952 )   $ (16,490 )   $ (36,435 )
 
   
 
     
 
     
 
     
 
 

     Activity in Accumulated Other Comprehensive Income for the nine months ended September 30, 2004 and 2003 was as follows:

 
                                 
                    Unrealized gains    
                    (losses) on derivative    
            Unrealized gains   instruments used in    
    Minimum pension   (losses) on securities   cash flow hedging    
(in thousands)
  liability
  available for sale
  relationships
  Total
Balance, December 31, 2002
  $ (195 )   $ 56,856     $ 5,639     $ 62,300  
Period change
          (26,233 )     (10,202 )     (36,435 )
 
   
 
     
 
     
 
     
 
 
Balance, September 30, 2003
  $ (195 )   $ 30,623     $ (4,563 )   $ 25,865  
 
   
 
     
 
     
 
     
 
 
Balance, December 31, 2003
  $ (1,309 )   $ 9,429     $ (5,442 )   $ 2,678  
Period change
          (19,555 )     3,065       (16,490 )
 
   
 
     
 
     
 
     
 
 
Balance, September 30, 2004
  $ (1,309 )   $ (10,126 )   $ (2,377 )   $ (13,812 )
 
   
 
     
 
     
 
     
 
 

14


Note 10 – Earnings per Share

     Basic earnings per share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares upon the exercise of stock options. The calculation of basic and diluted earnings per share for each of the three and nine months ended September 30 is as follows:

 
                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
(in thousands, except per share amount)
  2004
  2003
  2004
  2003
Income Before Cumulative Effect of Change in Accounting Principle
  $ 93,486     $ 104,212     $ 307,786     $ 292,432  
Net Income
  $ 93,486     $ 90,882     $ 307,786     $ 279,102  
Average common shares outstanding
    229,848       228,715       229,501       229,558  
Dilutive effect of common stock equivalents
    4,500       2,251       3,806       1,795  
 
   
 
     
 
     
 
     
 
 
Diluted Average Common Shares Outstanding
    234,348       230,966       233,307       231,353  
 
   
 
     
 
     
 
     
 
 
Earnings Per Share
                               
Basic
                               
Income before cumulative effect of change in accounting principle
  $ 0.41     $ 0.46     $ 1.34     $ 1.27  
Net Income
    0.41       0.40       1.34       1.22  
Diluted
                               
Income before cumulative effect of change in accounting principle
    0.40       0.45       1.32       1.26  
Net Income
    0.40       0.39       1.32       1.21  

     The average market price of Huntington’s common stock for the period was used in determining the dilutive effect of outstanding stock options. Common stock equivalents are computed based on the number of shares subject to stock options that have an exercise price less than the average market price of Huntington’s common stock for the period.

     Stock options for approximately 2.5 million and 6.4 million shares were vested and outstanding at September 30, 2004 and 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares for the period and, therefore, the effect would be antidilutive. The weighted average exercise price for these options was $27.04 per share and $23.19 per share at the end of the same respective periods.

     On July 30, 2004, Huntington entered into an agreement with the former shareholders of LeaseNet, Inc. to issue in early 2005 up to 86,118 shares of Huntington common stock previously held in escrow subject to LeaseNet meeting certain contractual performance criteria. A total of 366,576 common shares, previously held in escrow, will be returned to Huntington. All shares in escrow had been accounted for as treasury stock.

     On September 4, 2001, options totaling 3.2 million shares of common stock were granted to, with certain specified exceptions, full- and part-time employees under the Huntington Bancshares Incorporated Employee Stock Incentive Plan (the “Incentive Plan”). Under the terms of the Incentive Plan, these options were to vest on the earlier of September 4, 2006, or at such time as the closing price for Huntington’s common stock for five consecutive trading days reached or exceeded $25.00. Huntington’s common stock closing price exceeded $25.00 for each of the five consecutive trading days beginning October 1, 2004, and ending October 7, 2004. As a result, options for 2.0 million shares of common stock granted under the Incentive Plan, net of options for 1.2 million shares cancelled due to employee attrition, became fully vested and exercisable after the close of trading on October 7, 2004.

Note 11 – Stock-Based Compensation

     Huntington’s stock-based compensation plans are accounted for based on the intrinsic value method promulgated by APB Opinion 25, Accounting for Stock Issued to Employees , and related interpretations. Compensation expense for employee stock options is generally not recognized if the exercise price of the option equals or exceeds the fair value of the stock on the date of grant.

15


     The following pro forma disclosures for net income and earnings per diluted common share is presented as if Huntington had applied the fair value method of accounting of Statement No. 123 in measuring compensation costs for stock options. The fair values of the stock options granted were estimated using the Black-Scholes option-pricing model. This model assumes that the estimated fair value of the options is amortized over the options’ vesting periods and the compensation costs would be included in personnel expense on the income statement. The following table also includes the weighted-average assumptions that were used in the option-pricing model for options granted in each of the quarters presented:

 
                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Stock Options Outstanding at period end (in thousands)
    21,572       20,361       21,572       20,361  
Assumptions
                               
Risk-free interest rate
    3.78 %     4.49 %     3.78 %     4.36 %
Expected dividend yield
    3.19       3.37       3.19       3.32  
Expected volatility of Huntington’s common stock
    30.9       33.8       30.9       33.8  
Pro Forma Results (in millions of dollars)
                               
Net income, as reported
  $ 93.5     $ 90.9     $ 307.8     $ 279.1  
Less pro forma expense, net of tax, related to options granted
    3.7       3.5       10.1       9.4  
 
   
 
     
 
     
 
     
 
 
Pro Forma Net Income
  $ 89.8     $ 87.4     $ 297.7     $ 269.7  
 
   
 
     
 
     
 
     
 
 
Net Income Per Common Share:
                               
Basic, as reported
  $ 0.41     $ 0.40     $ 1.34     $ 1.22  
Basic, pro forma
    0.39       0.38       1.30       1.17  
Diluted, as reported
    0.40       0.39       1.32       1.21  
Diluted, pro forma
    0.38       0.38       1.28       1.17  

Note 12 – Restructuring Reserves

     On a quarterly basis, Huntington assesses its remaining restructuring reserves, primarily related to lease obligations, and makes adjustments to those reserves as necessary. Based on these assessments, Huntington released $1.2 million in the third quarter of 2004. Huntington had remaining reserves for restructuring of $5.1 million, $9.7 million, and $8.7 million, as of September 30, 2004, December 31, 2003, and September 30, 2003, respectively. Huntington expects that the reserves will be adequate to fund the estimated future cash outlays.

Note 13 – Benefit Plans

     Huntington sponsors the Huntington Bancshares Retirement Plan (the Plan), a non-contributory defined benefit pension plan covering substantially all employees. The Plan provides benefits based upon length of service and compensation levels. The funding policy of Huntington is to contribute an annual amount that is at least equal to the minimum funding requirements but not more than that deductible under the Internal Revenue Code. Although not required, Huntington made a discretionary contribution of $44.6 million to the Plan during the third quarter of 2004. In addition, Huntington has an unfunded, defined benefit post-retirement plan that provides certain healthcare and life insurance benefits to retired employees who have attained the age of 55 and have at least 10 years of vesting service under this plan. For any employee retiring on or after January 1, 1993, post-retirement healthcare benefits are based upon the employee’s number of months of service and are limited to the actual cost of coverage. Life insurance benefits are a percentage of the employee’s base salary at the time of retirement, with a maximum of $50,000 of coverage.

16


     The following table shows the components of net periodic benefit expense:

 
                                 
    Pension Benefits   Post Retirement Benefits
    Three Months Ended   Three Months Ended
    September 30,
  September 30,
(in thousands)
  2004
  2003
  2004
  2003
Service cost
  $ 3,040     $ 2,454     $ 326     $ 280  
Interest cost
    4,371       4,162       802       870  
Expected return on plan assets
    (5,383 )     (6,285 )            
Amortization of transition asset
          (63 )     276       276  
Amortization of prior service cost
                146       151  
Settlements
    1,000       1,089              
Recognized net actuarial loss
    1,984       444              
 
   
 
     
 
     
 
     
 
 
Benefit Expense
  $ 5,012     $ 1,801     $ 1,550     $ 1,577  
 
   
 
     
 
     
 
     
 
 
 
                                 
    Pension Benefits   Post Retirement Benefits
    Nine Months Ended   Nine Months Ended
    September 30,
  September 30,
(in thousands)
  2004
  2003
  2004
  2003
Service cost
  $ 9,118     $ 7,363     $ 976     $ 841  
Interest cost
    13,112       12,485       2,406       2,609  
Expected return on plan assets
    (16,147 )     (18,853 )            
Amortization of transition asset
          (189 )     828       827  
Amortization of prior service cost
                437       454  
Settlements
    3,000       3,265              
Recognized net actuarial loss
    5,952       1,330              
 
   
 
     
 
     
 
     
 
 
Benefit Expense
  $ 15,035     $ 5,401     $ 4,647     $ 4,731  
 
   
 
     
 
     
 
     
 
 

     Huntington also sponsors other retirement plans. One of those plans is an unfunded Supplemental Executive Retirement Plan. This plan is a nonqualified plan that provides certain former officers of Huntington and its subsidiaries with defined pension benefits in excess of limits imposed by federal tax law. Other plans, including plans assumed in various past acquisitions, are unfunded, nonqualified plans that provide certain active and former officers of Huntington and its subsidiaries nominated by Huntington’s compensation committee with deferred compensation, post-employment, and/or defined pension benefits in excess of the qualified plan limits imposed by federal tax law.

     Huntington has a 401(k) plan, which is a defined contribution plan that is available to eligible employees. Matching contributions by Huntington equal 100% on the first 3%, then 50% on the next 2%, of participant elective deferrals. The cost of providing this plan was $2.3 million and $2.1 million for the three months ended September 30, 2004 and 2003, respectively. For the respective nine-month periods, the cost was $7.0 million and $6.5 million.

17


 

Note 14 – Commitments and Contingent Liabilities

Commitments :

     In the ordinary course of business, Huntington makes various commitments to extend credit that are not reflected in the financial statements. The contract amount of these financial agreements at September 30, 2004, December 31, 2003, and September 30, 2003, were as follows:

                         
    September 30,   December 31,   September 30,
(in millions)
  2004
  2003
  2003
Contract amount represents credit risk
                       
Commitments to extend credit
                       
Commercial
    5,094       5,712       5,204  
Consumer
    3,898       3,652       3,488  
Commercial real estate
    483       952       927  
Standby letters of credit
    989       983       1,022  
Commercial letters of credit
    179       166       178  

     Commitments to extend credit generally have fixed expiration dates, are variable-rate, and contain clauses that permit Huntington to terminate or otherwise renegotiate the contracts in the event of a significant deterioration in the customer’s credit quality. These arrangements normally require the payment of a fee by the customer, the pricing of which is based on prevailing market conditions, credit quality, probability of funding, and other relevant factors. Since many of these commitments are expected to expire without being drawn upon, the contract amounts are not necessarily indicative of future cash requirements. The interest rate risk arising from these financial instruments is insignificant as a result of their predominantly short-term, variable-rate nature.

     Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Most of these arrangements mature within two years. The carrying amount of deferred revenue associated with these guarantees was $3.9 million, $3.8 million, and $3.9 million at September 30, 2004, December 31, 2003, and September 30, 2003, respectively.

     Commercial letters of credit represent short-term, self-liquidating instruments that facilitate customer trade transactions and generally have maturities of no longer than 90 days. The merchandise or cargo being traded normally secures these instruments.

Litigation:

     In the ordinary course of business, there are various legal proceedings pending against Huntington and its subsidiaries. In the opinion of management, the aggregate liabilities, if any, arising from such proceedings are not expected to have a material adverse effect on Huntington’s consolidated financial position. (See also Note 3.)

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

INTRODUCTION

     Huntington Bancshares Incorporated (Huntington or the company) is a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through its subsidiaries, Huntington is engaged in providing full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, and discount brokerage services, as well as reinsuring credit life and disability insurance, and selling other insurance and financial products and services. Huntington’s banking offices are located in Ohio, Michigan, West Virginia, Indiana, and Kentucky. Selected financial services are also conducted in other states including Arizona, Florida, Georgia, Maryland, New Jersey, Pennsylvania, and Tennessee. Huntington has a foreign office in the Cayman Islands and a foreign office in Hong Kong. The Huntington National Bank (the Bank), organized in 1866, is Huntington’s only bank subsidiary.

     The following discussion and analysis provides investors and others with information that Management believes to be necessary for an understanding of Huntington’s financial condition, changes in financial condition, results of operations, and cash flows, and should be read in conjunction with the financial statements, notes, and other information contained in this report.

Forward-Looking Statements

     This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements about Huntington. These include descriptions of products or services, plans or objectives of Management for future operations, including pending acquisitions, and forecasts of revenues, earnings, cash flows, or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.

     By their nature, forward-looking statements are subject to numerous assumptions, risks, and uncertainties. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, those set forth below and under the heading “Business Risks” included in Item 1 of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2003 (2003 Form 10-K), and other factors described in this report and from time-to-time in other filings with the Securities and Exchange Commission.

     Management encourages readers of this report to understand forward-looking statements to be strategic objectives rather than absolute forecasts of future performance. Forward-looking statements speak only as of the date they are made. Huntington assumes no obligation to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made or to reflect the occurrence of unanticipated events.

Risk Factors

     Huntington, like other financial companies, is subject to a number of risks, many of which are outside of Management’s control, though Management strives to manage those risks while optimizing returns. Among the risks assumed are: (1) credit risk, which is the risk that loan and lease customers or other counter parties will be unable to perform their contractual obligations, (2) market risk, which is the risk that changes in market rates and prices will adversely affect Huntington’s financial condition or results of operations, (3) liquidity risk, which is the risk that Huntington and / or the Bank will have insufficient cash or access to cash to meet operating needs, and (4) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people, or systems, or external events. The description of Huntington’s business contained in Item 1 of its 2003 Form 10-K, while not all inclusive, discusses a number of business risks that, in addition to the other information in this report, readers should carefully consider.

Formal Supervisory Agreements and Securities and Exchange Commission Investigation

     On November 3, 2004, Huntington announced that it expects to enter into formal supervisory agreements with its banking regulators, the Federal Reserve and the Office of the Controller of the Currency, providing for a comprehensive action plan designed to address its financial reporting and accounting policies, procedures, and controls and its corporate governance practices. Huntington remains in active dialogue with its banking regulators concerning these and related matters.

     As part of its November 3, 2004, announcement, Huntington indicated that it is negotiating a one-year extension of its merger agreement with Unizan. Huntington intends to withdraw its current application with the Federal Reserve to

19


acquire Unizan and to resubmit the application for regulatory approval of the merger once it has successfully resolved the aforementioned regulatory concerns.

     As previously disclosed, Huntington continues to have ongoing discussions with the staff of the Securities and Exchange Commission (SEC) regarding resolution of its formal investigation into certain financial accounting matters relating to fiscal years 2002 and earlier and certain related disclosure matters. It is anticipated that a settlement of this matter will involve the entry of an order by the SEC requiring Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a civil money penalty.

     Huntington’s Board of Directors has been overseeing a review of the Company’s financial accounting and reporting practices as they relate to the Company’s previous accounting restatements and other related matters during the course of the pending SEC formal investigation. It has recently engaged the Promontory Financial Group to provide assistance with respect to these and related regulatory matters.

     Huntington believes that it will be able to address all of the issues that have been raised by the SEC and its banking regulators concerning these matters in a comprehensive manner and is working aggressively to do so. No assurances, however, can be provided as to the ultimate timing or outcome of these matters pending a final settlement.

Critical Accounting Policies and Use of Significant Estimates

     Huntington’s 2003 Form 10-K lists Critical Accounting Policies and Use of Significant Estimates used in the development and presentation of its financial statements. These significant accounting policies, as well as the following discussion and analysis and other financial statement disclosures, identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of Huntington, its financial position, results of operations, and cash flows.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires Huntington’s Management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in its financial statements. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements of Huntington if a different amount within a range of estimates were used or if estimates changed from period to period. Readers of this interim report should understand that estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. Huntington’s Management has identified the most significant accounting estimates and their related application in Huntington’s 2003 Form 10-K.

SUMMARY DISCUSSION OF RESULTS

     Earnings comparisons from the first nine-months of 2003 through the first nine-months of 2004, including comparisons of third quarter of 2003 with the third quarter of 2004 performance, were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Understanding the nature and implications of these factors on financial results is important in understanding the company’s income statement, balance sheet, and credit quality trends and the comparison of the current quarter and year-to-date performance with comparable prior-year periods. The key factors impacting the current reporting period comparisons are more fully described in the Significant Factors Influencing Financial Performance Comparisons section, which follows the summary of results below.

2004 Third Quarter versus 2003 Third Quarter

     Huntington’s 2004 third quarter earnings were $93.5 million, or $0.40 per common share, both up 3% from $90.9 million and $0.39 per common share in the year-ago quarter. This $2.6 million increase in earnings primarily reflected:

  $39.8 million, or 77%, reduction in the provision for credit losses, reflecting improved credit quality performance,
 
  $26.8 million, or 9%, reduction in non-interest expense, primarily due to a decline in operating lease expense,
 
  $6.9 million, or 3%, increase in fully taxable equivalent net interest income, reflecting the benefit of an increase in earning assets, primarily loans and leases, partially offset by a decline in the net interest margin, and
 
  $13.3 million cumulative effect of a change in accounting principle, net of tax, in the year-ago quarter.

Partially offset by:

  $82.9 million, or 30%, decline in non-interest income, reflecting declines in operating lease income, mortgage banking income, gains on sale of automobile loans, and gain on sale of West Virginia banking offices, partially

20


    offset by higher investment securities gains, and
 
  $1.0 million, or 3%, increase in income tax expense, reflecting the impact of a higher effective tax rate.

        The return on average assets (ROA) and return on average equity (ROE), were 1.18% and 15.4%, respectively, down from 1.38% and 18.5%, respectively, in the year-ago quarter (see Table 1).

2004 Third Quarter versus 2004 Second Quarter

     Compared with 2004 second quarter net income of $110.1 million and $0.47 per common share, 2004 third quarter earnings and earnings per share were both down 15%. This $16.6 million decrease in earnings primarily reflected:

  $28.2 million, or 13%, decline in non-interest income, primarily due to declines in mortgage banking and operating lease income, partially offset by higher investment securities gains, and
 
  $6.8 million increase in the provision for credit losses, as the 2004 second quarter included the benefit of a $9.7 million one-time recovery on a single commercial (C&I) credit.

Partially offset by:

  $8.7 million, or 3%, decline in non-interest expense, primarily due to lower operating lease expense, and
 
  $4.4 million, or 2%, increase in fully taxable equivalent net interest income, reflecting the benefit of an increase in earning assets, primarily loans and leases, as well as a slight increase in the net interest margin,
 
  $5.1 million, or 12%, reduction in income tax expense, primarily as a result of the lower level of pre-tax income.

     The ROA and ROE were 1.18% and 15.4%, respectively, in the current quarter, down from 1.41% and 19.1%, respectively, in the prior quarter (see Table 1).

2004 First Nine Months versus 2003 First Nine Months

     Earnings for the first nine months of 2004 were $307.8 million, or $1.32 per common share, up 10% and 9%, respectively, from the comparable year-ago period earnings of $279.1 million or $1.21 per common share. This $28.7 million increase in earnings primarily reflected:

  $95.2 million, or 69%, reduction in the provision for credit losses, reflecting improved credit quality performance,
 
  $71.5 million, or 8%, reduction in non-interest expense, primarily due to a decline in operating lease expense, partially offset by higher personnel costs,
 
  $49.7 million, or 8%, increase in fully taxable equivalent net interest income, reflecting the benefit of an increase in earning assets, primarily loans and leases, partially offset by a decline in the net interest margin, and
 
  $13.3 million cumulative effect of a change in accounting principle, net of tax, in the year-ago period.

Partially offset by:

  $187.0 million, or 23%, decline in non-interest income, reflecting declines in operating lease income, mortgage banking income, and gains on sale of automobile loans and the absence of a gain on the sale of branch offices in the year-ago period, and
 
  $12.0 million, or 11%, increase in income tax expense, reflecting higher level of pre-tax income, as well as the impact of a slightly higher effective tax rate.

     The ROA and ROE were 1.32% and 17.6%, respectively, in the current nine-month period, down slightly from 1.37% and 17.9%, respectively, in the comparable year-ago period (see Table 2).

21


 

Table 1 — Selected Quarterly Income Statement Data

                                                         
     
2004
  2003
  3Q04 vs 3Q03
(in thousands, except per share amounts)
  Third
  Second
  First
  Fourth
  Third
  $ Chg
  % Chg
Interest Income
  $ 338,002     $ 324,167     $ 325,931     $ 335,097     $ 333,320     $ 4,682       1.4 %
Interest Expense
    110,944       101,604       103,246       110,782       112,849       (1,905 )     (1.7 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Interest Income
    227,058       222,563       222,685       224,315       220,471       6,587       3.0  
Provision for credit losses
    11,785       5,027       25,596       26,341       51,615       (39,830 )     (77.2 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Interest Income After Provision for Credit Losses
    215,273       217,536       197,089       197,974       168,856       46,417       27.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Operating lease income
    64,412       78,706       88,867       105,307       117,624       (53,212 )     (45.2 )
Service charges on deposit accounts
    43,935       43,596       41,837       44,763       42,294       1,641       3.9  
Trust services
    17,064       16,708       16,323       15,793       15,365       1,699       11.1  
Brokerage and insurance income
    13,200       13,523       15,197       14,344       13,807       (607 )     (4.4 )
Mortgage banking
    4,448       23,322       (4,296 )     9,677       30,193       (25,745 )     (85.3 )
Bank owned life insurance income
    10,019       11,309       10,485       10,410       10,438       (419 )     (4.0 )
Other service charges and fees
    10,799       10,645       9,513       9,237       10,499       300       2.9  
Gain on sales of automobile loans
    312       4,890       9,004       16,288             312        
Gain on sale of branch offices
                            13,112       (13,112 )     N.M.  
Securities gains (losses)
    7,803       (9,230 )     15,090       1,280       (4,107 )     11,910       N.M.  
Other
    17,899       24,659       25,619       19,411       23,543       (5,644 )     (24.0 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Non-Interest Income
    189,891       218,128       227,639       246,510       272,768       (82,877 )     (30.4 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Personnel costs
    121,729       119,715       121,624       115,762       113,170       8,559       7.6  
Operating lease expense
    54,885       62,563       70,710       85,609       93,134       (38,249 )     (41.1 )
Outside data processing and other services
    17,527       17,563       18,462       15,957       17,478       49       0.3  
Equipment
    15,295       16,228       16,086       16,840       16,328       (1,033 )     (6.3 )
Net occupancy
    16,838       16,258       16,763       14,925       15,570       1,268       8.1  
Professional services
    12,219       7,836       7,299       12,175       11,116       1,103       9.9  
Marketing
    5,000       8,069       7,839       6,895       5,515       (515 )     (9.3 )
Telecommunications
    5,359       4,638       5,194       5,272       5,612       (253 )     (4.5 )
Printing and supplies
    3,201       3,098       3,016       3,417       3,658       (457 )     (12.5 )
Amortization of intangibles
    204       204       204       204       204              
Loss on early extinguishment of debt
                      15,250                    
Restructuring reserve releases
    (1,151 )                 (351 )           (1,151 )      
Other
    22,317       25,981       18,457       25,510       18,397       3,920       21.3  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Non-Interest Expense
    273,423       282,153       285,654       317,465       300,182       (26,759 )     (8.9 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Income Before Income Taxes
    131,741       153,511       139,074       127,019       141,442       (9,701 )     (6.9 )
Provision for income taxes
    38,255       43,384       34,901       33,758       37,230       1,025       2.8  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Income before cumulative effect of change in accounting principle
    93,486       110,127       104,173       93,261       104,212       (10,726 )     (10.3 )
Cumulative effect of change in accounting principle, net of tax (1)
                            (13,330 )     13,330       N.M.  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Income
  $ 93,486     $ 110,127     $ 104,173     $ 93,261     $ 90,882     $ 2,604       2.9 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Average common shares - diluted
    234,348       232,659       232,915       231,986       230,966       3,382       1.5 %
Per Common Share:
                                                       
Income before cumulative effect of change in accounting principle - Diluted
  $ 0.40     $ 0.47     $ 0.45     $ 0.40     $ 0.45     $ (0.05 )     (11.1 )%
Net Income - Diluted
    0.40       0.47       0.45       0.40       0.39       0.01       2.6  
Cash Dividends Declared
    0.200       0.175       0.175       0.175       0.175       0.025       14.3  
Return on:
                                                       
Average total assets (2)
    1.18 %     1.41 %     1.36 %     1.22 %     1.38 %     (0.20 )%     (14.6 )
Average total shareholders’ equity (2)
    15.4       19.1       18.4       16.6       18.5       (3.04 )     (16.5 )
Net interest margin (3)
    3.30       3.29       3.36       3.42       3.46       (0.16 )     (4.6 )
Efficiency ratio (4)
    66.3       62.3       65.1       67.1       60.0       6.31       10.5  
Effective tax rate
    29.0       28.3       25.1       26.6       26.3       2.72       10.3  
Revenue - Fully Taxable Equivalent (FTE):
                                                       
Net Interest Income
  $ 227,058     $ 222,563     $ 222,685     $ 224,315     $ 220,471     $ 6,587       3.0  
FTE Adjustment (3)
    2,864       2,919       3,023       2,954       2,558       306       12.0  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Interest Income
    229,922       225,482       225,708       227,269       223,029       6,893       3.1  
Non-Interest Income
    189,891       218,128       227,639       246,510       272,768       (82,877 )     (30.4 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Revenue
  $ 419,813     $ 443,610     $ 453,347     $ 473,779     $ 495,797     $ (75,984 )     (15.3 )%
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 

N.M. - Not Meaningful.

(1)   Due to the adoption of FASB Interpretation No. 46 for variable interest entities.
 
(2)   Based on income before cumulative effect of change in accounting principle, net of tax.
 
(3)   On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
 
(4)   Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains (losses).

22


 

Table 2 - Selected YTD Income Statement Data

                                 
    Nine Months Ended September 30,
  2004 vs. 2003
(in thousands of dollars, except per share amounts)
  2004
  2003
  Amount
  %
Interest Income
  $ 988,100     $ 970,659     $ 17,441       1.8 %
Interest Expense
    315,794       345,988       (30,194 )     (8.7 )
 
   
 
     
 
     
 
     
 
 
Net Interest Income
    672,306       624,671       47,635       7.6  
Provision for credit losses
    42,408       137,652       (95,244 )     (69.2 )
 
   
 
     
 
     
 
     
 
 
Net Interest Income After Provision for Credit Losses
    629,898       487,019       142,879       29.3  
 
   
 
     
 
     
 
     
 
 
Operating lease income
    231,985       384,391       (152,406 )     (39.6 )
Service charges on deposit accounts
    129,368       123,077       6,291       5.1  
Trust services
    50,095       45,856       4,239       9.2  
Brokerage and insurance income
    41,920       43,500       (1,580 )     (3.6 )
Mortgage banking
    23,474       48,503       (25,029 )     (51.6 )
Bank owned life insurance income
    31,813       32,618       (805 )     (2.5 )
Other service charges and fees
    30,957       32,209       (1,252 )     (3.9 )
Gain on sales of automobile loans
    14,206       23,751       (9,545 )     (40.2 )
Gain on sale of branch offices
          13,112       (13,112 )     N.M.  
Securities gains (losses)
    13,663       3,978       9,685       N.M.  
Other
    68,177       71,648       (3,471 )     (4.8 )
 
   
 
     
 
     
 
     
 
 
Total Non-Interest Income
    635,658       822,643       (186,985 )     (22.7 )
 
   
 
     
 
     
 
     
 
 
Personnel costs
    363,068       331,501       31,567       9.5  
Operating lease expense
    188,158       307,661       (119,503 )     (38.8 )
Outside data processing and other services
    53,552       50,161       3,391       6.8  
Equipment
    47,609       49,081       (1,472 )     (3.0 )
Net occupancy
    49,859       47,556       2,303       4.8  
Professional services
    27,354       30,273       (2,919 )     (9.6 )
Marketing
    20,908       20,595       313       1.5  
Telecommunications
    15,191       16,707       (1,516 )     (9.1 )
Printing and supplies
    9,315       9,592       (277 )     (2.9 )
Amortization of intangibles
    612       612              
Loss on early extinguishment of debt
                       
Restructuring reserve releases
    (1,151 )     (6,315 )     5,164       (81.8 )
Other
    66,755       55,270       11,485       20.8  
 
   
 
     
 
     
 
     
 
 
Total Non-Interest Expense
    841,230       912,694       (71,464 )     (7.8 )
 
   
 
     
 
     
 
     
 
 
Income Before Income Taxes
    424,326       396,968       27,358       6.9  
Provision for income taxes
    116,540       104,536       12,004       11.5  
 
   
 
     
 
     
 
     
 
 
Income before cumulative effect of change in accounting principle
    307,786       292,432       15,354       5.3  
Cumulative effect of change in accounting principle, net of tax (1)
          (13,330 )     13,330       N.M.  
 
   
 
     
 
     
 
     
 
 
Net Income
  $ 307,786     $ 279,102     $ 28,684       10.3 %
 
   
 
     
 
     
 
     
 
 
Per Common Share
                               
Income before cumulative effect of change in accounting principle - Diluted
  $ 1.32     $ 1.26     $ 0.06       4.8 %
Net Income - Diluted
    1.32       1.21       0.11       9.1  
Cash Dividends Declared
    0.550       0.495       0.055       11.1  
Return on:
                               
Average total assets (2)
    1.32 %     1.37 %     (0.06 )%     (4.1 )%
Average total shareholders’ equity (2)
    17.6       17.9       (0.32 )     (1.8 )
Net interest margin (3)
    3.31       3.52       (0.21 )     (6.0 )
Efficiency ratio (4)
    64.5       62.9       1.61       2.6  
Effective tax rate
    27.5       26.3       1.13       4.3  
Revenue - Fully Taxable Equivalent (FTE):
                               
Net Interest Income
  $ 672,306     $ 624,671     $ 47,635       7.6 %
FTE Adjustment (3)
    8,806       6,730       2,076       30.8  
 
   
 
     
 
     
 
     
 
 
Net Interest Income
    681,112       631,401       49,711       7.9  
Non-Interest Income
    635,658       822,643       (186,985 )     (22.7 )
 
   
 
     
 
     
 
     
 
 
Total Revenue
  $ 1,316,770     $ 1,454,044     $ (137,274 )     (9.4 )%
 
   
 
     
 
     
 
     
 
 

N.M. - Not Meaningful.

(1)   Due to the adoption of FASB Interpretation No. 46 for variable interest entities.
 
(2)   Based on income before cumulative effect of change in accounting principle, net of tax.
 
(3)   On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
 
(4)   Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains.

23


Significant Factors Influencing Financial Performance Comparisons

     Earnings comparisons from the first nine months of 2003 through the first nine months of 2004 were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Those key factors are summarized below.

1.   Automobile leases originated through April 2002 are accounted for as operating leases – Automobile leases originated before May 2002 are accounted for using the operating lease method of accounting because they do not qualify as direct financing leases. Operating leases are a non-interest earning asset with the related rental income, other revenue, and credit recoveries reflected as operating lease income, a component of non-interest income. Under this accounting method, depreciation expenses, as well as other costs and charge-offs, are reflected as operating lease expense, a component of non-interest expense. With no new operating leases originated since April 2002, the operating lease assets are rapidly decreasing and will eventually run-off, along with related operating lease income and expense. Since operating lease income and expense represent a significant percentage of total non-interest income and expense, respectively, throughout this reporting period, their downward trend influences total non-interest income and non-interest expense trends.
 
    Automobile leases originated since April 2002 are accounted for as direct financing leases, an interest earning asset included in total loans and leases with the related income reflected as interest income and included in the calculation of the net interest margin. Credit charge-offs and recoveries are reflected in the allowance for loan and lease losses (ALLL), with related changes in the ALLL reflected in provision for credit losses. The relative newness and rapid growth of this portfolio has resulted in higher reported automobile lease growth rates than in a more mature portfolio. To better understand overall trends in automobile lease exposure, it is helpful to compare trends in the combined total of automobile leases plus operating leases (see the company’s 2003 Form 10-K for a full discussion).
 
2.   Transition from a weak economic environment in 2003 to a slow recovering economic environment in 2004. The weak economic environment resulted in continued weak demand for commercial and industrial (C&I) loans, which, when combined with strategies to lower the overall credit risk profile of the company (see below), has contributed to generally declining C&I loans throughout this period.
 
3.   Declining interest rates in 2003 with generally increasing, though fluctuating, interest rates in 2004. Interest rates impacted, among other factors, loan and deposit growth, the net interest margin, and the valuation of mortgage servicing rights (MSRs) and investment securities.

  The historically low interest rate environment in 2003 and 2004, despite a general increase in short-term rates during the first nine months of 2004, resulted in strong demand and resultant growth in residential real estate, home equity, and commercial real estate (CRE) loans generally throughout this period. Mortgage banking revenue was also favorably impacted by the significant mortgage origination activity.
 
  As interest rates fell in 2003, it became increasingly difficult to lower interest rates offered on deposit accounts commensurate with the overall decline in interest rates and yields on earning assets. This created an extremely competitive environment in which to grow deposits and resulted in an inability to lower deposit rates commensurate with the overall decline in earning asset rates. This contributed to the decline in the net interest margin throughout 2003. Though short-term interest rates have risen generally throughout the first nine months of 2004, they remain at historically low levels and the competition for deposits has remained very competitive. As a result, deposit rates have also risen thus not permitting much expansion in the net interest margin.
 
  Since the second quarter of 2002, the company generally has retained the servicing on mortgage loans it originates and sells. The mortgage servicing right (MSR) represents the present value of expected future net servicing income for the loan. MSR values are very sensitive to movements in interest rates. Expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise. Thus, as interest rates decline, less future income is expected and the value of MSRs declines and becomes impaired when the valuation is less than the recorded book value. The company recognizes temporary impairment due to change in interest rates through a valuation reserve and records a direct write-down of the book value of its MSRs

24


    for other-than-temporary declines in valuation. Changes and fluctuations in interest rate levels between quarters resulted in some quarters reporting an MSR temporary impairment, with others reporting a recovery of previously reported MSR temporary impairment. Such swings in MSR valuations have significantly impacted quarterly mortgage banking income throughout this period (see Table 3).
 
  The company uses gains or losses on investment securities, and more recently gains or losses on trading account assets, to offset MSR temporary valuation changes. As a result, changes in interest rate levels have also resulted in securities gains or losses and trading losses. As such, in quarters where an MSR temporary impairment is recognized, investment securities and/or trading account assets were sold resulting in a gain on sale, and vice versa. Investment securities gains or losses are reflected in the income statement in a single non-interest income line item, whereas trading gains or losses are a component of other non-interest income on the income statement. The earnings impact of the MSR valuation change and securities gain/loss may not exactly offset due to, among other factors, the difference in the timing of when the MSR valuation is determined and recorded, compared with when the securities are sold and any gain or loss is recorded (see Table 3).

4.   Management strategies to lower the overall credit risk profile of the balance sheet. Throughout this period, certain strategies were implemented to lower the overall credit risk profile of the balance sheet with the objective of lowering the volatility of earnings.

  Automobile loan sales – One strategy has been to lower the credit exposure to automobile loans and leases to at least 20% of total credit exposure, as manifested through the sale of automobile loans. These sales of higher-rate, higher-risk loans impact results in a number of ways including: lower growth rates in automobile, total consumer, and total company loans; the generation of gains reflected in non-interest income; lower net interest income than otherwise would be the case if the loans were not sold; and lower net interest margin (see Table 3).
 
  Reduction in large-individual C&I and CRE credits – This strategy has been reflected in the reduction in shared national credits, as well as other, mostly C&I loans. In addition, the company sold and charged-off lower-quality C&I and CRE credits in 2003 and 2004. This strategy was a contributing factor in the declines in C&I loan balances, NPAs, and the ALLL. In certain quarters, this strategy contributed to higher C&I net charge-offs.

5.   Adoption of FIN 46 – Effective July 1, 2003, the company adopted Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities . The adoption of FIN 46 resulted in the consolidation of $1.0 billion of previously securitized automobile loans and a $13.3 million after-tax charge in the 2003 third quarter for the cumulative effect of a change in accounting principle (see Tables 1 and 2).
 
6.   Corporate Restructuring Charges – 2003 and 2004 non-interest expense reflected recoveries of previously established corporate restructuring reserves, which were no longer needed (see Table 3) and lowered 2003 and 2004 non-interest expense (see Note 21 of the company’s 2003 Form 10-K Notes to Consolidated Financial Statements).
 
7.   Single commercial recovery – A single commercial credit recovery in the 2004 second quarter on a loan previously charged off in the 2002 fourth quarter favorably impacted the 2004 second quarter provision expense (see Table 3), as well as C&I, total commercial, and total net charge-offs for the quarter (see Table 11).
 
8.   Gain on the sale of West Virginia banking offices – In the 2003 third quarter, the company sold four banking offices in West Virginia which resulted in a $13.1 million gain (see Tables 1 and 2).
 
9.   SEC related expenses and accruals – As previously disclosed, the Securities and Exchange Commission (SEC) is conducting a formal investigation regarding certain financial accounting and disclosure matters, including certain matters that were the subject of prior restatements by Huntington (see Note 3 of the Notes to Unaudited Condensed Consolidated Financial Statements). For the first nine months of 2004, the company recorded certain expenses and accruals related to this investigation, most notably in the third quarter (see Table 3).

25


10.   Unizan system conversion expenses – On January 27, Huntington announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio (see Note 4 of the Notes to Unaudited Condensed Consolidated Financial Statements). In the 2004 third quarter, the company recorded certain integration planning and system conversion expenses related to this pending acquisition (see Table 3).

     The following table quantifies the earnings impact of changes in SEC related expenses / accruals, Unizan system conversion expenses, MSR and investment securities and trading account valuations, gains on sales of automobile loans, restructuring reserve releases, sale of the West Virginia banking offices, and a single, large commercial credit recovery on the  
specified periods.

Table 3 - Significant Items Influencing Earnings Performance Comparisons

                 
    Impact
(in millions, except per share )
  Pre-tax
  EPS
Three Months Ended:
               
 
September 30, 2004 - GAAP earnings
  $ 131.7     $ 0.40  
SEC related expenses / accruals
    (5.5 )     (0.02 )
Unizan system conversion expense
    (1.8 )     (0.01 )
Mortgage servicing right (MSR) temporary impairment
    (4.1 )     (0.01 )
MSR-related trading losses
    (2.3 )     (0.01 )
Investment securities gains
    7.8       0.02  
 
September 30, 2003 - GAAP earnings
  $ 141.4     $ 0.45  
SEC related expenses
    (4.7 )     (0.01 )
Gains on sale of West Virginia offices
    13.1       0.04  
MSR temporary impairment recovery
    17.8       0.05  
Investment securities losses
    (4.1 )     (0.01 )
 
Nine Months Ended:
               
 
September 30, 2004 - GAAP earnings
  $ 424.3     $ 1.32  
SEC related expenses / accruals
    (7.1 )     (0.02 )
Unizan system conversion expense
    (2.7 )     (0.01 )
Gains on sales of automobile loans
    14.2       0.04  
MSR-related trading losses
    (2.3 )     (0.01 )
Investment securities gains
    13.7       0.04  
Single commercial credit recovery
    9.7       0.03  
 
September 30, 2003 - GAAP earnings
  $ 397.0     $ 1.26  
SEC related expenses
    (5.1 )     (0.01 )
Gains on sale of West Virginia offices
    13.1       0.04  
Gains on sales of automobile loans
    23.8       0.07  
MSR temporary impairment recovery
    11.4       0.03  
Investment securities gains
    4.0       0.01  
Restructuring reserve releases
    6.3       0.02  

26


RESULTS OF OPERATIONS

Net Interest Income

2004 Third Quarter versus 2003 Third Quarter

     Fully taxable equivalent net interest income increased $6.9 million, or 3%, from the year-ago quarter, reflecting the favorable impact of an 8% increase in average earning assets, partially offset by a 16 basis point, or an effective 5%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.30% from 3.46%, reflecting the impact of lower rates and the strategic repositioning of portfolios to reduce automobile loans and to increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.

     Average total loans and leases increased $1.7 billion, or 8%, from the 2003 third quarter due primarily to a $1.3 billion, or 11%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.8 billion, or 84%, increase in average residential mortgages and a $0.5 billion, or 15%, increase in average home equity loans. Demand for residential mortgages and home equity loans remained strong during this twelve month period as interest rates remained near historically low levels. Average total automobile loans and leases decreased $1.1 billion, or 21%. This decline from the year-ago quarter reflected the sale of $2.6 billion of automobile loans over this 12-month period, partially offset by the rapid growth in direct financing leases due to the migration from operating lease assets, which have not been originated since April 2002.

     During the third quarter, $153 million of automobile loans were sold, including $102 million of automobile loans transferred to loans held for sale during the 2004 second quarter. Combined, these transactions resulted in third quarter net pre-tax gains on the sale of automobile loans of $0.3 million. On a combined basis, these transactions increased the total automobile loans sold since the beginning of 2003 to $3.7 billion. These sales represented a continuation of a strategy to reduce exposure to automobile financing to approximately 20% of total credit exposure (see Table 10). At September 30, 2004, this exposure was $4.9 billion, down from $6.2 billion at year end and represented 21% of total credit exposure, down from 28% at year end 2003, and 30% at September 30, 2003.

     Average total commercial and industrial (C&I) and commercial real estate (CRE) loan balances were $9.8 billion, up $0.4 billion, or 5%, from the year-ago quarter. This $9.8 billion consisted of middle-market C&I ($4.3 billion, down from $4.5 billion), middle market CRE ($3.5 billion, up from $3.1 billion), and small business C&I and CRE ($1.9 billion) loans. Small business C&I and CRE loans increased $188 million, or 11%. Middle-market C&I and CRE balances were impacted by a June 30, 2004 reclassification of $282 million of C&I loans to CRE loans. Adjusting for this reclassification, average middle-market C&I loans increased $93 million, or 2%, from the year-ago quarter and middle-market CRE loans increased $143 million, or 4%.

     Average investment securities increased $0.7 billion, or 18%, from the year-ago quarter. This increase reflected the use of some of the proceeds from the previous sales of automobile loans to purchase 10-year variable rate securities.

     Average total core deposits in the third quarter were $16.5 billion, up $0.7 billion, or 4%, from the year-ago quarter, reflecting a $0.8 billion, or 13%, increase in average interest bearing demand deposit accounts, partially offset by a $0.1 billion, or 6%, decline in retail CDs.

     Tables 4 and 5 reflect quarterly average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities:

27


 

Table 4 — Condensed Consolidated Quarterly Average Balance Sheets

                                                         
    Average Balances
   
                                            Change
(in millions)   2004
  2003
  3Q04 vs. 3Q03
Fully Taxable Equivalent Basis
  Third
  Second
  First
  Fourth
  Third
  Amount
  Percent
Assets
                                                       
Interest bearing deposits in banks
  $ 55     $ 69     $ 79     $ 83     $ 90     $ (35 )     (38.9 )%
Trading account securities
    148       28       16       11       11       137       N.M.  
Federal funds sold and securities purchased under resale agreements
    318       168       92       117       103       215       N.M.  
Loans held for sale
    283       254       207       295       898       (615 )     (68.5 )
Investment securities:
                                                       
Taxable
    4,340       4,861       4,646       4,093       3,646       694       19.0  
Tax exempt
    398       410       437       421       362       36       9.9  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Investment Securities
    4,738       5,271       5,083       4,514       4,008       730       18.2  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Loans and Leases:
                                                       
Commercial and industrial
    5,339       5,536       5,365       5,382       5,380       (41 )     (0.8 )
Real Estate
                                                       
Construction
    1,577       1,322       1,322       1,297       1,258       319       25.4  
Commercial
    2,890       2,906       2,876       2,830       2,744       146       5.3  
Consumer
                                                       
Automobile loans
    1,857       2,337       3,041       3,529       3,594       (1,737 )     (48.3 )
Automobile leases
    2,250       2,139       1,988       1,802       1,590       660       41.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Automobile Loans and Leases
    4,107       4,476       5,029       5,331       5,184       (1,077 )     (20.8 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Home equity (1)
    3,970       3,824       3,693       3,556       3,443       527       15.3  
Residential mortgage (1)
    3,906       3,326       2,846       2,624       2,122       1,784       84.1  
Other loans (1)
    406       377       371       386       381       25       6.6  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Consumer
    12,389       12,003       11,939       11,897       11,130       1,259       11.3  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Loans and Leases
    22,195       21,767       21,502       21,406       20,512       1,683       8.2  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Allowance for loan and lease losses
    (288 )     (310 )     (313 )     (350 )     (330 )     42       (12.7 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Loans and Leases
    21,907       21,457       21,189       21,056       20,182       1,725       8.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Earning Assets
    27,737       27,557       26,979       26,426       25,622       2,115       8.3  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Operating lease assets
    800       977       1,166       1,355       1,565       (765 )     (48.9 )
Cash and due from banks
    928       772       740       766       747       181       24.2  
Intangible assets
    216       216       217       217       218       (2 )     (0.9 )
All other assets
    2,072       2,101       2,046       2,008       2,061       11       0.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Assets
  $ 31,465     $ 31,313     $ 30,835     $ 30,422     $ 29,883     $ 1,582       5.3 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Liabilities and Shareholders’ Equity
                                                       
Core deposits
                                                       
Non-interest bearing deposits
  $ 3,276     $ 3,223     $ 3,017     $ 3,131     $ 3,218     $ 58       1.8 %
Interest bearing demand deposits
    7,384       7,168       6,609       6,466       6,558       826       12.6  
Savings deposits
    2,841       2,839       2,819       2,824       2,808       33       1.2  
Retail certificates of deposit
    2,414       2,400       2,399       2,492       2,561       (147 )     (5.7 )
Other domestic time deposits
    595       600       637       631       656       (61 )     (9.3 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Core Deposits
    16,510       16,230       15,481       15,544       15,801       709       4.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Domestic time deposits of $100,000 or more
    886       795       788       828       803       83       10.3  
Brokered time deposits and negotiable CDs
    1,755       1,737       1,907       1,851       1,421       334       23.5  
Foreign time deposits
    476       542       549       522       536       (60 )     (11.2 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Deposits
    19,627       19,304       18,725       18,745       18,561       1,066       5.7  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Short-term borrowings
    1,342       1,396       1,603       1,433       1,393       (51 )     (3.7 )
Federal Home Loan Bank advances
    1,270       1,270       1,273       1,273       1,273       (3 )     (0.2 )
Subordinated notes and other long-term debt, including preferred capital securities
    5,244       5,623       5,557       5,432       5,197       47       0.9  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Interest Bearing Liabilities
    24,207       24,370       24,141       23,752       23,206       1,001       4.3  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
All other liabilities
    1,570       1,397       1,399       1,311       1,220       350       28.7  
Shareholders’ equity
    2,412       2,323       2,278       2,228       2,239       173       7.7  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Liabilities and Shareholders’ Equity
  $ 31,465     $ 31,313     $ 30,835     $ 30,422     $ 29,883     $ 1,582       5.3 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 

N.M. - Not Meaningful

(1) Consumer loans that are secured by a first mortgage on residential property are presented as “residential mortgage loans.” Consumer loans that are secured by a junior mortgage on residential property are presented as “Home equity loans” Reclassification of prior period balances have been made to conform with this presentation.

28


 

Table 5 - Consolidated Quarterly Net Interest Margin Analysis

                                         
    Average Rates (2)
    2004
  2003
Fully Taxable Equivalent Basis (1)
  Third
  Second
  First
  Fourth
  Third
Assets
                                       
Interest bearing deposits in banks
    0.91 %     1.05 %     0.71 %     0.60 %     0.51 %
Trading account securities
    4.44       3.02       3.98       2.39       4.70  
Federal funds sold and securities purchased under resale agreements
    1.53       1.21       1.41       1.30       1.92  
Loans held for sale
    5.25       5.17       5.33       5.31       5.16  
Securities:
                                       
Taxable
    3.83       3.83       4.06       4.24       4.23  
Tax exempt
    7.06       7.07       6.88       6.91       6.93  
 
   
 
     
 
     
 
     
 
     
 
 
Total Securities
    4.10       4.09       4.30       4.49       4.47  
 
   
 
     
 
     
 
     
 
     
 
 
Loans and Leases:
                                       
Commercial and industrial
    4.63       4.25       4.49       4.82       4.84  
Real Estate
                                       
Construction
    4.11       3.70       3.68       4.24       4.17  
Commercial
    4.76       4.57       4.70       4.99       5.22  
Consumer
                                       
Automobile loans
    7.65       7.20       6.93       6.90       7.19  
Automobile leases
    5.02       5.06       4.94       4.98       4.99  
 
   
 
     
 
     
 
     
 
     
 
 
Automobile Loans and Leases
    6.21       6.17       6.14       6.25       6.51  
 
   
 
     
 
     
 
     
 
     
 
 
Home equity (3)
    4.72       4.73       4.47       4.75       5.03  
Residential mortgage (3)
    5.52       5.36       5.16       5.24       5.34  
Other loans (3)
    6.89       6.33       5.62       8.15       7.93  
 
   
 
     
 
     
 
     
 
     
 
 
Total Consumer
    5.54       5.49       5.52       5.64       5.87  
 
   
 
     
 
     
 
     
 
     
 
 
Total Loans and Leases
    5.12       4.95       5.04       5.26       5.41  
 
   
 
     
 
     
 
     
 
     
 
 
Total Earning Assets
    4.89 %     4.76 %     4.89 %     5.11 %     5.23 %
 
   
 
     
 
     
 
     
 
     
 
 
Liabilities and Shareholders’ Equity
                                       
Core deposits
                                       
Non-interest bearing deposits
                                       
Interest bearing demand deposits (4)
    1.06 %     0.94 %     0.88 %     0.91 %     1.04 %
Savings deposits
    0.83       0.82       0.94       1.22       1.35  
Retail certificates of deposit
    3.32       3.27       3.47       3.54       3.51  
Other domestic time deposits
    3.22       3.19       3.48       3.69       3.89  
 
   
 
     
 
     
 
     
 
     
 
 
Total Core Deposits
    1.52       1.45       1.53       1.65       1.76  
 
   
 
     
 
     
 
     
 
     
 
 
Domestic time deposits of $100,000 or more
    2.40       2.37       2.14       2.37       2.32  
Brokered time deposits and negotiable CDs
    1.84       1.57       1.51       1.52       1.63  
Foreign time deposits
    0.83       0.76       0.72       0.75       0.85  
 
   
 
     
 
     
 
     
 
     
 
 
Total Deposits
    1.58       1.48       1.53       1.64       1.75  
 
   
 
     
 
     
 
     
 
     
 
 
Short-term borrowings
    0.92       0.80       0.83       0.78       0.85  
Federal Home Loan Bank advances
    2.60       2.52       2.50       2.24       1.81  
Subordinated notes and other long-term debt, including preferred capital securities
    2.62       2.24       2.33       2.63       2.78  
 
   
 
     
 
     
 
     
 
     
 
 
Total Interest Bearing Liabilities
    1.82 %     1.66 %     1.71 %     1.85 %     1.93 %
 
   
 
     
 
     
 
     
 
     
 
 
Net interest rate spread
    3.07 %     3.10 %     3.18 %     3.26 %     3.30 %
Impact of non-interest bearing funds on margin
    0.23       0.19       0.18       0.16       0.16  
 
   
 
     
 
     
 
     
 
     
 
 
Net Interest Margin
    3.30 %     3.29 %     3.36 %     3.42 %     3.46 %
 
   
 
     
 
     
 
     
 
     
 
 

(1)   Fully taxable equivalent (FTE) yields are calculated assuming a 35% tax rate. See Table 1 for the FTE adjustment.
 
(2)   Loan and lease and deposit average rates include impact of applicable derivatives and non-deferrable fees.
 
(3)   Consumer loans that are secured by a first mortgage on residential property are presented as “residential mortgage loans.” Consumer loans that are secured by a junior mortgage on residential property are presented as “Home equity loans.” Reclassification of prior period balances have been made to conform with this presentation.
 
(4)   The 2004 second quarter calculation has been corrected to conform to other periods presented.

29


2004 Third Quarter versus 2004 Second Quarter

     Compared with the 2004 second quarter, fully taxable equivalent net interest income increased $4.4 million, or 2%, reflecting the favorable impact of a 1% increase in average earning assets and a one basis point increase in the net interest margin to 3.30% from 3.29%.

     Compared with the second quarter, average total loans and leases increased $0.4 billion, or 2%, with the growth rate mitigated by a $0.5 billion, or 21%, decline in average automobile loans due to the second quarter ($512 million) and third quarter ($153 million) sales of automobile loans. Growth in mortgage-related consumer loans remained strong with average residential mortgages up $0.6 billion, or 17%, and average home equity loans up $0.1 billion, or 4%. Total average C&I and CRE loans increased slightly, primarily reflecting a $63 million, or 3%, increase in small business C&I and CRE loans. As discussed above, middle-market C&I and CRE loan balances were impacted by the $282 million loan reclassification on June 30, 2004. Adjusting for this reclassification, third quarter average middle-market C&I and CRE loans were essentially flat.

     Compared with the second quarter, average investment securities declined $0.5 billion, or 10%.

     Compared with the 2004 second quarter, average total core deposits increased $0.3 billion, or 2%, reflecting growth in interest bearing demand deposits, up $0.2 billion, or 3%, as well as non-interest bearing deposits, up $0.1 billion, or 2%.

2004 First Nine Months versus 2003 First Nine Months

     Fully taxable equivalent net interest income for the first nine months of 2004 increased $49.7 million, or 8%, from the comparable year-ago period, reflecting the favorable impact of a 14% increase in average earning assets, partially offset by a 21 basis point, or an effective 6%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.31% from 3.52%, reflecting the impact of lower rates and the strategic repositioning of portfolios to reduce automobile loans and increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.

     Average total loans and leases increased $2.3 billion, or 12%, from the first nine months of 2003 due primarily to a $2.0 billion, or 19%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.4 billion, or 72%, increase in average residential mortgages and a $0.5 billion, or 15%, increase in average home equity loans. Average total automobile loans and leases increased $0.1 billion, or 1%. This growth from the year-ago, nine-month period reflected the positive impact of underlying new automobile loan originations, the 2003 third quarter consolidation of a $1.0 billion automobile loan securitization trust, and the rapid growth in direct financing leases due to the migration from operating lease assets, which are no longer being originated. Partially offsetting these positive impacts was the sale of automobile loans over this period.

     Average total C&I and CRE loans in the first nine months of 2004 increased $0.3 billion, or 3%, from the comparable year-ago period reflecting an 11% increase in small business C&I and CRE loans, and a 11% increase in middle-market CRE loans. Average middle-market C&I loans were down 5% from the year-ago period and reflected both weak demand and the impact from continued strategies to specifically lower exposure to large individual commercial credits, including shared national credits.

     Average investment securities increased $1.4 billion, or 38%, from the year-ago nine-month period primarily reflecting the investment of a portion of the proceeds from the automobile loan sales.

     Average total core deposits in the first nine months of 2004 were $16.1 billion, up $0.7 billion, or 4%, from the comparable year-ago period. This growth primarily reflected a $1.0 billion, or 16%, increase in interest bearing demand deposits, primarily money market accounts, partially offset by a $0.4 billion, or 13%, decline in retail CDs.

     Table 6 reflects average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities, respectively, for the first nine-month periods of 2004 and 2003:

30


 

Table 6 - Condensed Consolidated YTD Average Balance Sheets and Net Interest Margin Analysis

                                                 
    YTD Average Balances
  YTD Average Rates (2)
(in millions)   Nine Months Ending Sept 30,
  2004 vs. 2003
  Nine Months Ending Sept 30,
Fully Tax Equivalent Basis (1)
  2004
  2003
  Amount
  %
  2004
  2003
Assets
                                               
Interest bearing deposits in banks
  $ 67     $ 58     $ 9       15.5       0.88 %     1.53 %
Trading account securities
    64       16       48       N.M.       4.17       4.41  
Federal funds sold and securities purchased under resale agreements
    193       76       117       N.M.       1.42       2.05  
Loans held for sale
    248       654       (406 )     (62.1 )     5.24       5.32  
Securities:
                                               
Taxable
    4,615       3,350       1,265       37.8       3.91       4.63  
Tax exempt
    415       304       111       36.5       7.00       7.09  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Securities
    5,030       3,654       1,376       37.7       4.17       4.83  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Loans and Leases:
                                               
Commercial and industrial
    5,413       5,542       (129 )     (2.3 )     4.45       5.17  
Real Estate
                                               
Construction
    1,408       1,229       179       14.6       3.85       4.22  
Commercial
    2,891       2,644       247       9.3       4.67       5.31  
Consumer
                                               
Automobile loans
    2,410       3,170       (760 )     (24.0 )     7.20       7.56  
Automobile leases
    2,126       1,304       822       63.0       5.00       5.15  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Automobile loans and leases
    4,536       4,474       62       1.4       6.17       6.86  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Home equity (3)
    3,830       3,337       493       14.8       4.65       4.97  
Residential mortgage (3)
    3,361       1,958       1,403       71.7       5.36       5.64  
Other loans (3)
    384       383       1       0.3       6.30       7.92  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Consumer
    12,111       10,152       1,959       19.3       5.52       6.05  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total Loans and Leases
    21,823       19,567       2,256       11.5       5.03       5.59  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Allowance for loan and lease losses
    (314 )     (350 )     36       (10.3 )                
 
   
 
     
 
     
 
     
 
                 
Net loans and leases
    21,509       19,217       2,292       11.9                  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total earning assets
    27,425       24,025       3,400       14.2       4.84 %     5.45 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Operating lease assets
    980       1,812       (832 )     (45.9 )                
Cash and due from banks
    814       740       74       10.0                  
Intangible assets
    216       218       (2 )     (0.9 )                
All other assets
    2,074       2,010       64       3.2                  
 
   
 
     
 
     
 
     
 
                 
Total Assets
  $ 31,195     $ 28,455     $ 2,740       9.6                  
 
   
 
     
 
     
 
     
 
                 
Liabilities and Shareholders’ Equity
                                               
Core deposits
                                               
Non-interest bearing deposits
  $ 3,172     $ 3,063     $ 109       3.6                  
Interest bearing demand deposits
    7,055       6,100       955       15.7       0.96 %     1.28 %
Savings deposits
    2,833       2,795       38       1.4       0.86       1.58  
Retail certificates of deposit
    2,404       2,773       (369 )     (13.3 )     3.35       3.72  
Other domestic time deposits
    611       670       (59 )     (8.8 )     3.30       3.91  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total core deposits
    16,075       15,401       674       4.4       1.50       2.04  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Domestic time deposits of $100,000 or more
    823       793       30       3.8       2.31       2.54  
Brokered time deposits and negotiable CDs
    1,800       1,274       526       41.3       1.64       1.79  
Foreign time deposits
    522       492       30       6.1       0.77       0.98  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total deposits
    19,220       17,960       1,260       7.0       1.53       2.01  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Short-term borrowings
    1,447       1,656       (209 )     (12.6 )     0.85       1.04  
Federal Home Loan Bank advances
    1,271       1,253       18       1.4       2.54       1.80  
Subordinated notes and other long-term debt, including preferred capital securities
    5,474       4,265       1,209       28.3       2.39       2.89  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total interest bearing liabilities
    24,240       22,071       2,169       9.8       1.74 %     2.09 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
All other liabilities
    1,445       1,137       308       27.1                  
Shareholders’ equity
    2,338       2,184       154       7.1                  
 
   
 
     
 
     
 
     
 
                 
Total Liabilities and Shareholders’ Equity
  $ 31,195     $ 28,455     $ 2,740       9.6                  
 
   
 
     
 
     
 
     
 
                 
Net interest rate spread
                                    3.10 %     3.36 %
Impact of non-interest bearing funds on margin
                                    0.21       0.16  
 
                                   
 
     
 
 
Net Interest Margin
                                    3.31 %     3.52 %
 
                                   
 
     
 
 

(1)  Fully taxable equivalent (FTE) yields are calculated assuming a 35% tax rate. See Table 2 for the FTE adjustment.

(2)  Loan and lease and deposit average rates include impact of applicable derivatives and non-deferrable fees.

(3)  Consumer loans that are secured by a first mortgage on residential property are presented as “residential mortgage loans.” Consumer loans that are secured by a junior mortgage on residential property are presented as “Home equity loans.” Reclassification of prior period balances have been made to conform with this presentation.

31


Provision for Credit Losses

     The provision for credit losses is the expense necessary to maintain the ALLL and the allowance for unfunded loan commitments (AULC) at levels adequate to absorb Management’s estimate of inherent losses in the total loan and direct financing lease portfolio, unfunded loan commitments, and letters of credit. Taken into consideration are such factors as current period net charge-offs that are charged against these allowances, current period loan and lease growth and any related estimate of likely losses associated with that growth based on historical experience, the current economic outlook, and the anticipated impact on credit quality of existing loans and leases, unfunded commitments and letters of credit (see Allowances for Credit Losses for additional discussion and Table 14).

     The provision for credit losses in the 2004 third quarter was $11.8 million, a $39.8 million reduction from the year-ago quarter and a $6.8 million increase from the 2004 second quarter. The reduction from the year-ago quarter reflected overall improved portfolio quality performance, as well as an improved economic outlook, only partially offset by provision expense related to loan growth. The increase in provision for credit losses from the 2004 second quarter reflected the fact that the 2004 second quarter provision benefited from a $9.7 million recovery on a single C&I credit that had been charged-off in the 2002 fourth quarter. Underlying credit quality trends between the 2004 second and third quarter continued to improve. As previously disclosed, effective January 1, 2004, the company adopted a more quantitative approach to calculating the economic reserve component of the ALLL, making this component more responsive to changes in economic conditions. This change, combined with the existing quantitative approach for determining the transaction reserve component, as well as changes to the specific reserve component, will result in more volatility in the total ALLL and corresponding provision for credit losses (see Credit Risk for additional discussion).

     The provision for credit losses in the first nine months of 2004 was $42.4 million, a $95.2 million, or 69%, decline from the comparable year-ago period. This reduction reflected the same factors impacting third quarter year-over-year performance.

32


Non-Interest Income

     Table 7 reflects non-interest income detail for each of the past five  
quarters, and the first nine-months of 2004 and 2003:

Table 7 — Non-Interest Income

                                                         
    2004
  2003
  3Q04 vs. 3Q03
(in thousands)
  Third
  Second
  First
  Fourth
  Third
  Amount
  Percent
Service charges on deposit accounts
  $ 43,935     $ 43,596     $ 41,837     $ 44,763     $ 42,294     $ 1,641       3.9 %
Trust services
    17,064       16,708       16,323       15,793       15,365       1,699       11.1  
Brokerage and insurance
    13,200       13,523       15,197       14,344       13,807       (607 )     (4.4 )
Mortgage banking
    4,448       23,322       (4,296 )     9,677       30,193       (25,745 )     (85.3 )
Bank owned life insurance
    10,019       11,309       10,485       10,410       10,438       (419 )     (4.0 )
Gain on sale of automobile loans
    312       4,890       9,004       16,288             312        
Gain on sale of branch offices
                            13,112       (13,112 )     N.M.  
Other service charges and fees
    10,799       10,645       9,513       9,237       10,499       300       2.9  
Securities gains (losses)
    7,803       (9,230 )     15,090       1,280       (4,107 )     11,910       N.M.  
Other
    17,899       24,659       25,619       19,411       23,543       (5,644 )     (24.0 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Sub-total before operating lease income
    125,479       139,422       138,772       141,203       155,144       (29,665 )     (19.1 )
Operating lease income
    64,412       78,706       88,867       105,307       117,624       (53,212 )     (45.2 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Non-Interest Income
  $ 189,891     $ 218,128     $ 227,639     $ 246,510     $ 272,768     $ (82,877 )     (30.4 )%
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
 
                                 
    Nine Months Ending    
    September 30,
  2004 vs. 2003
(in thousands)
  2004
  2003
  Amount
  Percent
Service charges on deposit accounts
  $ 129,368     $ 123,077     $ 6,291       5.1 %
Trust services
    50,095       45,856       4,239       9.2  
Brokerage and insurance
    41,920       43,500       (1,580 )     (3.6 )
Mortgage banking
    23,474       48,503       (25,029 )     (51.6 )
Bank owned life insurance
    31,813       32,618       (805 )     (2.5 )
Gain on sale of automobile loans
    14,206       23,751       (9,545 )     (40.2 )
Gain on sale of branch offices
          13,112       (13,112 )     N.M.  
Other service charges and fees
    30,957       32,209       (1,252 )     (3.9 )
Securities gains (losses)
    13,663       3,978       9,685       N.M.  
Other
    68,177       71,648       (3,471 )     (4.8 )
 
   
 
     
 
     
 
     
 
 
Sub-total before operating lease income
    403,673       438,252       (34,579 )     (7.9 )
Operating lease income
    231,985       384,391       (152,406 )     (39.6 )
 
   
 
     
 
     
 
     
 
 
Total Non-Interest Income
  $ 635,658     $ 822,643     $ (186,985 )     (22.7 )%
 
   
 
     
 
     
 
     
 
 

N.M. — Not Meaningful.

2004 Third Quarter versus 2003 Third Quarter

     Non-interest income decreased $82.9 million, or 30%, from the year-ago quarter. Comparisons with prior-period results are heavily influenced by the decline in operating leases and related operating lease income. These trends are expected to continue as all automobile leases originated since April 2002 are direct financing leases with income reflected in net interest income, not non-interest income. Reflecting the run-off of the operating lease portfolio, operating lease income declined $53.2 million, or 45%, from the 2003 third quarter. Excluding operating lease income, non-interest income decreased $29.7 million, or 19%, from the year-ago quarter with the primary drivers being:

  $25.7 million, or 85%, decrease in mortgage banking income. This reflected a $21.9 million change in MSR temporary impairment valuations, as the current quarter included a $4.1 million MSR temporary impairment compared with a $17.8 million recovery of previously recorded MSR temporary impairment recognized in the year-ago quarter. MSR valuations are very sensitive to movements in interest rates. Excluding the MSR temporary impairment valuation change between quarters, mortgage banking income decreased $3.8 million, primarily reflecting lower secondary marketing gains and lower origination volume.

  $13.1 million gain on sale of branch offices in the year ago quarter with no such gain in the current quarter.

  $5.6 million, or 24%, decline in other income due to lower investment banking income and the MSR-related trading loss. To offset the volatility that results from recognizing temporary MSR valuation changes, Huntington has used investment securities and, more recently, other trading account assets, including forward commitments

33


and options. As none of these instruments qualify for hedge accounting, the change in value of the trading account assets are reported as a component of other income, whereas the gains (losses) from the sale of securities that are available for sale are reported as investment securities gains (losses).

Partially offset by:

  $11.9 million increase in investment securities gains as the current quarter reflected gains of $7.8 million compared with $4.1 million of securities losses in the year-ago quarter.

  $1.7 million, or 11%, increase in trust services income as a result of higher personal trust fees, reflecting higher average asset values and higher money market mutual fund fees.

  $1.6 million, or 4%, increase in service charges on deposit accounts due to higher service charges on personal accounts.

2004 Third Quarter versus 2004 Second Quarter

     Compared with the 2004 second quarter, non-interest income declined $28.2 million, or 13%. This comparison is also heavily influenced by the decline in operating lease income for the reasons noted above. Reflecting the run-off of the operating lease portfolio, operating lease income declined $14.3 million, or 18%, from the 2004 second quarter. Excluding operating lease income, non-interest income decreased $13.9 million, or 10%, from the 2004 second quarter with the primary drivers being:

  $18.9 million, or 81%, decrease in mortgage banking income. This reflected a $19.0 million change in MSR temporary impairment valuations, as the current quarter included a $4.1 million MSR temporary impairment compared with a $14.9 million recovery of previously recorded MSR temporary impairment recognized in the second quarter. This increase in MSR temporary impairment valuation between quarters reflected the downward movement in mortgage interest rates in the third quarter. The MSR temporary impairment valuation reserve at September 30, 2004 was $5.5 million. Reflecting the decline in interest rates during the quarter, the value of MSRs as a percent of mortgages serviced for others was 1.13%, down from 1.21% at June 30, 2004.

  $6.8 million, or 27%, decrease in other income reflecting the MSR-related trading loss in the current quarter, as well as a decline in investment banking and trading fee income.

  $4.6 million decrease in gain on sale of automobile loans as the current quarter reflected $0.3 million of gains, compared with $4.9 million of gains in the second quarter.

Partially offset by:

  $17.0 million increase in securities gains (losses), with the current quarter reflecting $7.8 million in securities gains, compared with $9.2 million of securities losses in the 2004 second quarter.

2004 First Nine Months versus 2003 First Nine Months

     Non-interest income for the first nine months of 2004 declined $187.0 million, or 23%, from the comparable year-ago period. Comparisons with prior-period results are heavily influenced by the decline in operating leases and related operating lease income (see above discussion). Reflecting the run-off of the operating lease portfolio, operating lease income for the first nine months of 2004 declined $152.4 million, or 40%, from the comparable year-ago period. Excluding operating lease income, non-interest income for the first nine months of 2004 decreased $34.6 million, or 8%, from the comparable year-ago period with the primary drivers being:

  $25.0 million, or 52%, decline in mortgage banking income. This reflected a $10.8 million change in MSR temporary impairment valuations, as the current nine-month period included $0.6 million recovery of previously recorded MSR temporary impairment compared with an $11.4 million recovery of previously recorded MSR temporary impairment in the comparable year-ago period. The remainder of the decline primarily reflected lower secondary marketing gains and lower origination volume.

  $13.1 million gain on sale of branch offices in the year-ago nine-month period with no such gain in the comparable

34


    current year period.

  $9.5 million reduction in the gain on sale of automobile loans.

  $3.5 million decline in other income, including a $2.3 million loss on trading activity in the current year period to offset MSR temporary valuation changes, as well as lower investment banking income.

Partially offset by:

  $9.7 million increase in gains from the sale of investment securities to offset MSR temporary valuation changes.

  $6.3 million, or 5%, increase in service charges on deposit accounts.

  $4.2 million, or 9%, increase in trust services.

35


Non-Interest Expense

     Table 8 reflects non-interest expense detail for each of the last five  
quarters and the first nine-month period for 2004 and 2003:

Table 8 - Non-Interest Expense

                                                         
    2004
  2003
  3Q04 vs. 3Q03
(in thousands)
  Third
  Second
  First
  Fourth
  Third
  Amount
  Percent
Personnel costs
  $ 121,729     $ 119,715     $ 121,624     $ 115,762     $ 113,170     $ 8,559       7.6 %
Outside data processing and other services
    17,527       17,563       18,462       15,957       17,478       49       0.3  
Equipment
    15,295       16,228       16,086       16,840       16,328       (1,033 )     (6.3 )
Net occupancy
    16,838       16,258       16,763       14,925       15,570       1,268       8.1  
Professional services
    12,219       7,836       7,299       12,175       11,116       1,103       9.9  
Marketing
    5,000       8,069       7,839       6,895       5,515       (515 )     (9.3 )
Telecommunications
    5,359       4,638       5,194       5,272       5,612       (253 )     (4.5 )
Printing and supplies
    3,201       3,098       3,016       3,417       3,658       (457 )     (12.5 )
Amortization of intangible assets
    204       204       204       204       204              
Loss on early extinguishment of debt
                      15,250                    
Restructuring reserve releases
    (1,151 )                 (351 )           (1,151 )      
Other
    22,317       25,981       18,457       25,510       18,397       3,920       21.3  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Sub-total before operating lease expense
    218,538       219,590       214,944       231,856       207,048       11,490       5.5  
Operating lease expense
    54,885       62,563       70,710       85,609       93,134       (38,249 )     (41.1 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Non-Interest Expense
  $ 273,423     $ 282,153     $ 285,654     $ 317,465     $ 300,182     $ (26,759 )     (8.9 )%
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
 
                                 
    Nine Months Ending    
    September 30,
  2004 vs. 2003
(in thousands)
  2004
  2003
  Amount
  Percent
Personnel costs
  $ 363,068     $ 331,501     $ 31,567       9.5 %
Outside data processing and other services
    53,552       50,161       3,391       6.8  
Equipment
    47,609       49,081       (1,472 )     (3.0 )
Net occupancy
    49,859       47,556       2,303       4.8  
Professional services
    27,354       30,273       (2,919 )     (9.6 )
Marketing
    20,908       20,595       313       1.5  
Telecommunications
    15,191       16,707       (1,516 )     (9.1 )
Printing and supplies
    9,315       9,592       (277 )     (2.9 )
Amortization of intangible assets
    612       612              
Restructuring reserve releases
    (1,151 )     (6,315 )     5,164       (81.8 )
Other
    66,755       55,270       11,485       20.8  
 
   
 
     
 
     
 
     
 
 
Sub-total before operating lease expense
    653,072       605,033       48,039       7.9  
Operating lease expense
    188,158       307,661       (119,503 )     (38.8 )
 
   
 
     
 
     
 
     
 
 
Total Non-Interest Expense
  $ 841,230     $ 912,694     $ (71,464 )     (7.8 )%
 
   
 
     
 
     
 
     
 
 

2004 Third Quarter versus 2003 Third Quarter

     Non-interest expense decreased $26.8 million, or 9%, from the year-ago quarter. Comparisons with prior-period results are influenced by the decline in operating lease expense as the operating lease portfolio continues to run-off (see above operating lease income discussion). Excluding operating lease expense, non-interest expense increased $11.5 million, or 6%, from the year-ago quarter with the primary drivers being:

    $8.6 million, or 8%, increase in personnel costs primarily reflecting higher salaries and benefits expense, partially offset by lower sales commissions due to weaker mortgage origination and capital market activities.
 
    $3.9 million, or 21%, increase in other expense reflecting higher automobile lease residual value losses, as well as SEC-related expenses and accruals.
 
    $1.3 million, or 8%, increase in net occupancy expense.
 
    $1.1 million, or 10%, increase in professional services including SEC-related expenses.

Partially offset by:

    $1.2 million benefit from the release of restructuring reserves in the current quarter.

36


    $1.0 million, or 6%, decline in equipment expense.

     The current quarter included $1.8 million of current quarter expenses related to Unizan integration planning and systems conversion. These expenses were spread across various non-interest expense categories with no meaningful impact on any single line item.

2004 Third Quarter versus 2004 Second Quarter

     Compared with the 2004 second quarter, non-interest expense declined $8.7 million, or 3%. Comparisons with prior-period results are also heavily influenced by the decline in operating lease expense. Operating lease expense declined $7.7 million, or 12%, from the 2004 second quarter. Excluding operating lease expense, non-interest expense decreased $1.1 million from the second quarter with the primary drivers being:

    $3.7 million, or 14%, decrease in other expense as the second quarter included $5.8 million of costs related to investments in partnerships generating tax benefits for the first half of 2004. The 2004 third quarter other expense included automobile lease residual value losses, as well as SEC-related expenses and accruals.
 
    $3.1 million, or 38%, decrease in marketing expense due to lower advertising expenditures.
 
    $1.2 million benefit from the release of restructuring reserves in the current quarter.

Partially offset by:

    $4.4 million, or 56%, increase in professional services primarily reflecting SEC-related expenses.
 
    $2.0 million, or 2%, increase in personnel costs.

2004 First Nine Months versus 2003 First Nine Months

     Non-interest expense for the first nine months of 2004 declined $71.5 million, or 8%, from the comparable year-ago period. Comparisons with prior-period results are influenced by the decline in operating lease expense as the operating lease portfolio continues to run-off (see above operating lease income discussion). Operating lease expense declined $119.5 million, or 39%, from the 2003 nine-month period.

     Excluding operating lease expense, non-interest expense for the first nine months of 2004 increased $48.0 million, or 8%, from the year-ago period with the primary drivers being:

    $31.6 million, or 10%, increase in personnel costs primarily reflecting a $17.3 million, or 28%, increase in benefits expense and an $17.0 million, or 8%, increase in salaries.
 
    $11.5 million, or 21%, increase in other expense reflecting $5.8 million of costs related to investments in partnerships generating tax benefits in the current nine-month period and to a lesser degree accruals for pending litigation and SEC-related costs.
 
    $5.2 million in restructuring reserve releases that lowered expenses in the year-ago nine-month period.

37


Operating Lease Assets

     Table 9 reflects operating lease assets performance detail for each of the  
last five quarters, and the first nine-months of 2004 and 2003:

Table 9 - Operating Lease Performance

                                                         
    2004
  2003
  3Q04 vs. 3Q03
    Third
  Second
  First
  Fourth
  Third
  Amount
  Percent
Balance Sheet (in millions)
                                                       
Average operating lease assets outstanding
  $ 800     $ 977     $ 1,166     $ 1,355     $ 1,565     $ (765 )     (49) %
Income Statement (in thousands)
                                                       
Net rental income
  $ 60,267     $ 72,402     $ 83,517     $ 98,223     $ 109,645     $ (49,378 )     (45) %
Fees
    2,965       4,838       3,543       5,204       5,372       (2,407 )     (44.8 )
Recoveries - early terminations
    1,180       1,466       1,807       1,880       2,607       (1,427 )     (54.7 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Operating Lease Income
    64,412       78,706       88,867       105,307       117,624       (53,212 )     (45.2 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Depreciation and residual losses at termination
    49,917       57,412       63,823       76,768       83,112       (33,195 )     (39.9 )
Losses - early termination
    4,968       5,151       6,887       8,841       10,022       (5,054 )     (50.4 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Operating Lease Expense
    54,885       62,563       70,710       85,609       93,134       (38,249 )     (41.1 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Earnings Contribution
  $ 9,527     $ 16,143     $ 18,157     $ 19,698     $ 24,490     $ (14,963 )     (61.1) %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Earnings ratios (1)
                                                       
Net rental income
    30.1 %     29.6 %     28.7 %     29.0 %     28.0 %     2.1 %     7.5 %
Depreciation and residual losses at termination
    25.0       23.5       21.9       22.7       21.2       3.7       17.5  

(1) As a percent of average operating lease assets, quarterly amounts annualized.

 
                                 
    Nine Months Ended    
    September 30,
  2004 vs. 2003
    2004
  2003
  Amount
  Percent
Balance Sheet (in millions)
                               
Average operating lease assets outstanding
  $ 980     $ 1,812     $ (831 )     (45.9 )%
Income Statement (in thousands)
                               
Net rental income
  $ 216,186     $ 360,421     $ (144,235 )     (40.0 )%
Fees
    11,346       16,419       (5,073 )     (30.9 )
Recoveries - early terminations
    4,453       7,551       (3,098 )     (41.0 )
 
   
 
     
 
     
 
     
 
 
Total Operating Lease Income
    231,985       384,391       (152,406 )     (39.6 )
 
   
 
     
 
     
 
     
 
 
Depreciation and residual losses at termination
    171,152       273,782       (102,630 )     (37.5 )
Losses - early termination
    17,006       33,879       (16,873 )     (49.8 )
 
   
 
     
 
     
 
     
 
 
Total Operating Lease Expense
    188,158       307,661       (119,503 )     (38.8 )
 
   
 
     
 
     
 
     
 
 
Net Earnings Contribution
  $ 43,827     $ 76,730     $ (32,903 )     (42.9 )%
 
   
 
     
 
     
 
     
 
 
Earnings ratios (1)
                               
Net rental income
    29.4 %     26.5 %     2.9 %     10.8 %
Depreciation and residual losses at termination
    23.3       20.2       3.1       15.6  

(1)   As a percent of average operating lease assets, quartlery amounts annualized.

38


     Operating lease assets represent automobile leases originated before May 2002. This operating lease portfolio will run-off over time since all automobile lease originations after April 2002 have been recorded as direct financing leases and are reported in the automobile loan and lease category in earning assets. As a result, the non-interest income and non-interest expenses associated with the operating lease portfolio will also decline over time.

2004 Third Quarter versus 2003 Third Quarter and 2004 Second Quarter

     Average operating lease assets in the 2004 third quarter were $0.8 billion, down $0.8 billion, or 49%, from the year-ago quarter and 18% from the 2004 second quarter.

     Operating lease income, which totaled $64.4 million in the 2004 third quarter, represented 34% of non-interest income in the quarter. Operating lease income was down $53.2 million, or 45%, from the year-ago quarter and $14.3 million, or 18%, from the 2004 second quarter, reflecting the declines in average operating leases. As no new operating leases have been originated after April 2002, the operating lease asset balances will continue to decline through both depreciation and lease terminations. Net rental income was down 45% and 17%, respectively, from the year-ago and 2004 second quarter. Fees declined 45% from the year-ago quarter and 39% from the second quarter reflecting the recognition of deferred fees resulting from higher than expected prepayments of operating lease assets in the second quarter of this year. Recoveries from early terminations declined 55% from the year-ago quarter and 20% from the second quarter.

     Operating lease expense totaled $54.9 million, down $38.2 million, or 41%, from the year-ago quarter and down $7.7 million, or 12%, from the 2004 second quarter. These declines also reflected the fact that this portfolio is decreasing over time as no new operating leases are being originated. The decline in operating lease expense from the year-ago quarter was partially offset by a $3.5 million increase in additional depreciation expense for the estimated decline in residual values.

     Losses on operating lease assets consist of residual losses at termination and losses on early terminations. Residual losses arise if the ultimate value or sales proceeds from the automobile are less than Black Book value, which represents the insured amount under the company’s residual value insurance policies. This situation may occur due to excess wear-and-tear or excess mileage not collected from the lessee. Losses on early terminations occur when a lessee, due to credit or other reasons, turns in the automobile before the end of the lease term. A loss is realized if the automobile is sold for a value less than the net book value at the date of turn-in. Such losses are not covered by the residual value insurance policies. To the extent the company is successful in collecting any deficiency from the lessee, amounts received are recorded as recoveries from early terminations.

     Credit losses on operating lease assets are included in operating lease expense and were $5.0 million in the current quarter, down from $10.0 million in the year-ago quarter and $5.2 million in the second quarter. Recoveries on operating lease assets are included in operating lease income and totaled $1.2 million, $2.6 million, and $1.5 million, for the same periods, respectively. The ratio of operating lease asset credit losses to average operating lease assets, net of recoveries, was an annualized 1.89% in the current quarter, 1.90% in the year-ago quarter, and 1.51% in the 2004 second quarter. As noted in the non-interest income discussion above, the operating lease portfolio will decline over time as no new operating lease assets have been generated since April 2002.

     On a quarterly basis, Management evaluates the amount of residual value losses that it anticipates will result from the estimated fair value of a leased vehicle being less than the residual value inherent in the lease. Fair value includes estimated net proceeds from the sale of the leased vehicle plus expected residual value insurance proceeds and amounts expected to be collected from the lessee for excess mileage and other items that are billable under terms of the lease contract. When estimating the amount of expected insurance proceeds, Management takes into consideration policy caps that exist in two of the three residual value insurance policies and whether it expects aggregate claims under such policies to exceed these caps. Residual value losses exceeding any insurance policy cap are reflected in higher depreciation expense over the remaining life of the affected automobile lease. Also as part of its quarterly analysis, Management evaluates automobile leases individually for impairment.

     Residual value losses on automobile leases booked prior to October 1, 2000, were covered by an insurance policy with a $120 million cap. During the third quarter, residual value losses exceeded this cap a few months earlier than anticipated due to higher than anticipated volume of turned in automobiles and to a lesser degree, softness in the used car market. Total losses above the cap are expected to be $18-$30 million, including $10 million already recognized and reflected in additional accumulated depreciation. As a result, the company anticipates that 2004 fourth quarter operating lease depreciation will be $2-$3 million higher than the 2004 third quarter expense level, with lesser amounts in quarters thereafter.

39


     The residual value insurance policy covering automobile leases originated between October 1, 2000 and April 30, 2002 contains a $50 million cap. At this time, the company anticipates that total claims against this policy will be $10-$18 million, well below the cap. To date, approximately $3 million of claims have been filed on this policy. All automobile leases originated since April 30, 2002, are covered under a policy that does not place a cap on losses. This policy will cover leases originated through April 30, 2005.

2004 First Nine Months versus 2003 First Nine Months

     Average operating lease assets in the first nine-months of 2004 were $1.0 billion, down $0.8 billion, or 46%, from the comparable year-ago period.

     Operating lease income, which totaled $232.0 million in the first nine months of 2004, represented 36% of non-interest income, and was down $152.4 million, or 40%, from the comparable year-ago period. Net rental income was down $144.2 million, or 40%. Fees declined $5.1 million, or 31%, from the same year-ago period. Recoveries from early terminations declined $3.1 million, or 41% from the year-ago period. Operating lease expense totaled $188.2 million, down $119.5 million, or 39%, from the comparable year-ago period. The declines in operating lease income and operating lease expense reflected the fact that this portfolio is decreasing over time as no new operating leases are being originated, and the same factors discussed above.

     The ratio of operating lease asset credit losses to average operating lease assets, net of recoveries, was an annualized 1.71% in the first nine months of 2004, down from 1.94% in the comparable year-ago period.

Provision for Income Taxes

     The provision for income taxes in the third quarter of 2004 was $38.3 million and represented an effective tax rate on income before taxes of 29.0%. The provision for income taxes increased $1.0 million from the year-ago quarter, due to a higher effective tax rate. The effective tax rates in the second quarter of 2004 and the third quarter 2003 were 28.3% and 26.3%, respectively. The higher effective tax rate in the 2004 third quarter reflected a reduction in estimated 2004 tax benefits (credits) from a reduced level of investments in partnerships and the recording of non-deductible expenses.

     For the first nine months of 2004, provision for income taxes was $116.5 million and represented an effective tax rate on income before taxes of 27.5%. This represented an increase of $12.0 million from the same period in 2003, in which the effective tax rate was 26.3%, reflecting higher pre-tax income.

     Each quarter, taxes for the full year are estimated and year-to-date tax accrual adjustments are made. Revisions to the full year estimate of accrued taxes occur periodically due to changes in the tax rates, audit resolution with taxing authorities, and newly enacted statutory, judicial, and regulatory guidance. These changes, when they occur, affect accrued taxes and can result in fluctuations in the quarterly effective tax rate.

     In accordance with FAS 109, Accounting for Income Taxes , no deferred income taxes are to be recorded when a company intends to permanently reinvest their earnings from a foreign activity. As of September 30, 2004, the company intended to permanently reinvest the earnings from its foreign asset securitization activities of approximately $83.7 million.

     Management expects the 2004 effective tax rate to remain below 30% as the level of tax-exempt income, general business credits, and asset securitization activities remain consistent with prior years.

40


CREDIT RISK

     Credit risk is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed upon terms. The company is subject to credit risk in lending, trading, and investment activities. The nature and degree of credit risk is a function of the types of transactions, the structure of those transactions, and the parties involved. The majority of the company’s credit risk is associated with lending activities, as the acceptance and management of credit risk is central to profitable lending. Credit risk represents a limited portion of the total risks associated with the investment portfolio and is incidental to trading activities. Credit risk is mitigated through a combination of credit policies and processes and portfolio diversification. These include origination/underwriting criteria, portfolio monitoring processes, and effective problem asset management. There are very specific and differing methodologies for managing credit risk for commercial credits compared with consumer credits (see Credit Risk Management section of the Company’s 2003 Form 10-K for a complete discussion).

Loan and Lease Composition

     Table 10 reflects period-end loan and lease portfolio mix by type of loan  
or lease, as well as by business segment:

Table 10 - Loans and Lease Portfolio Composition

                                                                                 
    September 30, 2004
  June 30, 2004 (1)
  March 31, 2004
  December 31, 2003
  September 30, 2003
(in millions)
  Amount
  %
  Amount
  %
  Amount
  %
  Amount
  %
  Amount
  %
By Type
                                                                               
Commercial
                                                                               
Commercial and industrial
  $ 5,440       23.3 %   $ 5,277       23.3 %   $ 5,480       24.6 %   $ 5,314       23.8 %   $ 5,433       24.0 %
Commercial real estate
    4,473       19.2       4,514       19.9       4,272       19.2       4,172       18.6       4,047       17.8  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Commercial
    9,913       42.5       9,791       43.2       9,752       43.7       9,486       42.4       9,480       41.8  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Consumer
                                                                               
Automobile loans
    1,885       8.1       1,814       8.0       2,267       10.2       2,992       13.4       3,709       16.4  
Automobile leases
    2,317       9.9       2,185       9.6       2,066       9.3       1,902       8.5       1,688       7.4  
Home equity (2)
    4,047       17.4       3,906       17.2       3,757       16.9       3,639       16.3       3,498       15.4  
Residential mortgage (2)
    4,004       17.2       3,690       16.3       2,976       13.4       2,681       12.0       2,415       10.6  
Other loans (2)
    422       1.8       389       1.7       375       1.7       375       1.7       383       1.7  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Consumer
    12,675       54.4       11,984       52.9       11,441       51.3       11,589       51.8       11,693       51.6  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Loans and Direct Financing Leases
  $ 22,588       96.9     $ 21,775       96.1     $ 21,193       95.1     $ 21,075       94.2     $ 21,173       93.4  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Operating lease assets
    717       3.1       889       3.9       1,071       4.8       1,260       5.6       1,455       6.4  
Securitized loans
                            28       0.1       37       0.2       49       0.2  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Credit Exposure
  $ 23,305       100.0 %   $ 22,664       100.0 %   $ 22,292       100.0 %   $ 22,372       100.0 %   $ 22,677       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Automoble Exposure (3)
  $ 4,919       21.1 %   $ 4,888       21.6 %   $ 5,432       24.4 %   $ 6,191       27.7 %   $ 6,901       30.4 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
By Business Segment (4)
                                                                               
Regional Banking
                                                                               
Central Ohio
  $ 5,944       25.5 %   $ 5,652       24.9 %   $ 4,988       22.4 %   $ 4,652       20.8 %   $ 4,491       19.8 %
Northern Ohio
    2,809       12.1       2,694       11.9       2,681       12.0       2,579       11.5       2,639       11.6  
Southern Ohio/Kentucky
    1,826       7.8       1,759       7.8       1,703       7.6       1,677       7.5       1,623       7.2  
West Michigan
    2,236       9.6       2,216       9.8       2,155       9.7       2,077       9.3       2,028       8.9  
East Michigan
    1,388       6.0       1,359       6.0       1,341       6.0       1,268       5.7       1,306       5.8  
West Virginia
    866       3.7       811       3.6       808       3.6       802       3.6       802       3.5  
Indiana
    863       3.7       811       3.6       753       3.4       731       3.3       741       3.3  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Regional Banking
    15,932       68.4       15,302       67.5       14,429       64.7       13,786       61.7       13,630       60.1  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Dealer Sales
    5,774       24.8       5,840       25.8       6,399       28.7       7,095       31.6       7,598       33.5  
Private Financial Group
    1,395       6.0       1,381       6.1       1,322       5.9       1,296       5.8       1,260       5.6  
Treasury / Other
    204       0.9       141       0.6       142       0.7       195       0.9       189       0.8  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Credit Exposure
  $ 23,305       100.0 %   $ 22,664       100.0 %   $ 22,292       100.0 %   $ 22,372       100.0 %   $ 22,677       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 

(1)   Effective June 30, 2004, $282 million of commercial and industrial loans were reclassified to commercial real estate to conform to the classification of these loans with the presentation of similar loans.
 
(2)   Consumer loans that are secured by a first mortgage on residential property are presented as “residential mortgage loans.” Consumer loans that are secured by a junior mortgage on residential property are presented as “Home equity loans.” Reclassification of prior period balances have been made to conform with this presentation.
 
(3)   Sum of automobile loans and leases, operating lease assets, and securitized loans.
 
(4)   Prior period amounts have been reclassified to conform to the current period business segment structure.

     During 2004, the composition of the loan and lease portfolio changed such that lower credit risk home equity loans and residential mortgages each represented 17% of total credit exposure at September 30, 2004, up from 15% and 11%, respectively, a year earlier. Conversely, C&I loans have declined from 24% a year ago to 23% at September 30, 2004, reflecting, in part, strategies to exit large, individual commercial credits, including out-of-footprint shared national credits.

41


     At the beginning of the 2004 second quarter, the criteria for categorizing commercial loans as either C&I loans or CRE loans was clarified. The new criteria are based on the purpose of the loan. Previously, the categorization was based on the nature of the collateral securing, or partially securing, the loan. Under this new methodology, as new loans are originated or existing loans renewed, loans secured by owner-occupied real estate are categorized as C&I loans (previously CRE loans) and unsecured loans for the purpose of developing real estate are categorized as CRE loans (previously C&I loans). As a result of this change, $282 million in C&I loans were reclassified to CRE loans effective June 30, 2004. Prior periods were not reclassified. This change had no impact on the underlying credit quality of total commercial loans. However, it did increase average reported CRE loans in the 2004 third quarter by $282 million, with an equal decrease in average reported C&I loans.

     The company also has a portfolio of automobile operating lease assets. Although these assets are reflected on the balance sheet, they are not part of total loans and leases or earning assets. In addition, prior to June 30, 2004, there was a small pool of securitized automobile loans, which represented off-balance sheet securitized automobile loan assets. Both of these asset classes represent automobile financing credit exposure, despite not being components of total loans and leases. As such, operating lease assets and securitized loans are added to the on-balance sheet automobile loans and leases to determine a total automobile financing exposure, which Management finds helpful in evaluating the overall credit risk for the company.

     During the third quarter of 2004, $153 million of automobile loans were sold, resulting in a third quarter pre-tax gain on the sale of automobile loans of $0.3 million. This sale increased the total automobile loans sold since the beginning of 2003 to $3.7 billion. These sales represented a continuation of a strategy to reduce exposure to automobile financing to approximately 20% of total credit exposure (see Table 10). At September 30, 2004, this exposure was $4.9 billion, down from $6.2 billion at year-end, and represented 21% of total credit exposure, down from 22% at the end of the last quarter and from 30% a year earlier.

Net Loan and Lease Charge-offs

     Table 11 reflects net loan and lease charge-off detail for each of the last  
five quarters, and the first nine-month period for 2003 and 2004:

Table 11 - Net Loan and Lease Charge-offs

Net Charge-offs by Loan and Lease Type

                                         
    2004
  2003
(in thousands)
  Third
  Second
  First
  Fourth
  Third
Commercial and industrial
  $ 972     $ (2,803 )   $ 5,956     $ 31,186     $ 12,222  
Commercial real estate
    1,592       2,940       1,637       5,743       3,621  
 
   
 
     
 
     
 
     
 
     
 
 
Total Commercial
    2,564       137       7,593       36,929       15,843  
 
   
 
     
 
     
 
     
 
     
 
 
Consumer
                                       
Automobile loans
    5,142       5,604       13,422       11,346       10,773  
Automobile direct financing leases
    2,415       2,159       3,159       1,936       1,450  
 
   
 
     
 
     
 
     
 
     
 
 
Automobile loans and leases
    7,557       7,763       16,581       13,282       12,223  
 
   
 
     
 
     
 
     
 
     
 
 
Home equity
    4,527       3,019       3,116       3,464       3,416  
Residential mortgage
    534       302       316       174       246  
Other loans
    1,298       1,294       1,021       1,294       1,046  
 
   
 
     
 
     
 
     
 
     
 
 
Total Consumer
    13,916       12,378       21,034       18,214       16,931  
 
   
 
     
 
     
 
     
 
     
 
 
Total Net Charge-offs
  $ 16,480     $ 12,515     $ 28,627     $ 55,143     $ 32,774  
 
   
 
     
 
     
 
     
 
     
 
 
 

Net Charge-offs - Annualized Percentages

                                         
    2004
  2003
    Third
  Second
  First
  Fourth
  Third
Commercial and industrial
    0.07 %     (0.20) %     0.44 %     2.32 %   $ 0.91 %
Commercial real estate
    0.14       0.28       0.16       0.56       0.36  
 
   
 
     
 
     
 
     
 
     
 
 
Total Commercial
    0.10       0.01       0.32       1.55       0.68  
 
   
 
     
 
     
 
     
 
     
 
 
Consumer
                                       
Automobile loans
    1.11       0.96       1.77       1.29       1.20  
Automobile direct financing leases
    0.43       0.40       0.64       0.43       0.36  
 
   
 
     
 
     
 
     
 
     
 
 
Automobile loans and leases
    0.74       0.69       1.32       1.00       0.94  
 
   
 
     
 
     
 
     
 
     
 
 
Home equity
    0.46       0.32       0.34       0.39       0.40  
Residential mortgage
    0.05       0.04       0.04       0.03       0.05  
Other loans
    1.28       1.38       1.11       1.34       1.10  
 
   
 
     
 
     
 
     
 
     
 
 
Total Consumer
    0.45       0.41       0.70       0.61       0.61  
 
   
 
     
 
     
 
     
 
     
 
 
Net Charge-offs as a % of Average Loans
    0.30 %     0.23 %     0.53 %     1.03 %     0.64 %
 
   
 
     
 
     
 
     
 
     
 
 

42


 

Table 11 - Net Loan and Lease Charge-offs Continued

Net Charge-offs by Loan and Lease Type

                 
    Nine Months Ending
    September 30,
(in thousands)
  2004
  2003
Commercial and industrial
  $ 4,125     $ 53,672  
Commercial real estate
    6,169       4,774  
 
   
 
     
 
 
Total Commercial
    10,294       58,446  
 
   
 
     
 
 
Consumer
               
Automobile loans
    24,168       28,920  
Automobile direct financing leases
    7,733       3,792  
 
   
 
     
 
 
Automobile loans and leases
    31,901       32,712  
 
   
 
     
 
 
Home equity
    10,662       11,140  
Residential mortgage
    1,152       658  
Other loans
    3,613       3,710  
 
   
 
     
 
 
Total Consumer
    47,328       48,220  
 
   
 
     
 
 
Total Net Charge-offs
  $ 57,622     $ 106,666  
 
   
 
     
 
 
 

Net Charge-offs - Annualized Percentages

                 
    Nine Months Ending
    September 30,
    2004
  2003
Commercial and industrial
    0.10 %     1.29 %
Commercial real estate
    0.19       0.16  
 
   
 
     
 
 
Total Commercial
    0.14       0.83  
 
   
 
     
 
 
Consumer
               
Automobile loans
    1.34       1.22  
Automobile direct financing leases
    0.48       0.39  
 
   
 
     
 
 
Automobile loans and leases
    0.94       0.97  
 
   
 
     
 
 
Home equity
    0.37       0.45  
Residential mortgage
    0.05       0.04  
Other loans
    1.25       1.29  
 
   
 
     
 
 
Total Consumer
    0.52       0.63  
 
   
 
     
 
 
Net Charge-offs as a % of Average Loans
    0.35 %     0.73 %
 
   
 
     
 
 

2004 Third Quarter versus 2003 Third Quarter and 2004 Second Quarter

     Total net charge-offs for the 2004 third quarter were $16.5 million, or an annualized 0.30% of average total loans and leases. This was a reduction from $32.8 million, or 0.64%, in the year-ago quarter. However, it was an increase from $12.5 million in the second quarter, or an annualized 0.23% of average total loans and leases, as net charge-offs in the second quarter were reduced by a $9.7 million one-time recovery of a previously charged-off commercial loan. This recovery lowered total commercial (C&I and CRE) net charge-offs by 39 basis points and total loan and lease net charge-offs by 18 basis points. Excluding the impact of this recovery, 2004 second quarter total net charge-offs would have been $22.2 million, or an annualized 0.41% of average total loans and leases. Gross charge-offs in the third quarter declined $4.5 million, or 15%, from the second quarter.

     Total commercial net charge-offs in the third quarter were $2.6 million, or an annualized 0.10%, down from $15.8 million, or an annualized 0.68%, in the year-ago quarter and up from only $137 thousand in the previous quarter. Adjusting for the $9.7 million recovery noted above (39 basis point impact), second quarter total commercial net charge-offs would have been $9.8 million, or an annualized 0.40% of related loans.

     Total consumer net charge-offs in the current quarter were $13.9 million, or an annualized 0.45% of related loans. This compared with $16.9 million, or 0.61%, in the year-ago quarter and $12.4 million, or an annualized 0.41% of related loans in the 2004 second quarter.

     Total automobile loan and lease net charge-offs in the 2004 third quarter were $7.6 million, or an annualized 0.74% of average automobile loans and leases. This compared with $12.2 million of net charge-offs, or an annualized 0.94%, in the year-ago quarter and $7.8 million, or an annualized 0.69% in the second quarter.

43


      2004 First Nine Months versus 2003 First Nine Months

     Total net charge-offs for the first nine months of 2004 were $57.6 million, or an annualized 0.35% of average total loans and leases. This was a 46% reduction from $106.7 million, or 0.73%, in the comparable year-ago period. Performance for the first nine months of 2004 was consistent with the company’s net charge-off target of 0.35%-0.45% for a stable economic environment.

     Total commercial (C&I and CRE) net charge-offs in the first nine months of 2004 were only $10.3 million, or an annualized 0.14%, down from $58.4 million, or 0.83%, in the comparable year-ago period. The decline from the year-ago period reflected improved credit quality, including lower non-performing assets (NPAs), as well as the benefit of a $9.7 million C&I recovery in the 2004 first nine-month period.

     Total consumer net charge-offs in the first nine months of 2004 were $47.3 million, or an annualized 0.52% of related loans. This compared with $48.2 million, or 0.63%, in the comparable year-ago period. Total automobile loan and lease net charge-offs in the first nine months of 2004 were $31.9 million, or an annualized 0.94% of average automobile loans and leases, down slightly from $32.7 million, or an annualized 0.97% of average automobile loans and leases in the year-ago nine-month period.

Non-performing Assets and Past Due Loans and Leases

     Table 12 reflects period-end NPAs and past due loans and leases detail for  
each of the last five quarters:

Table 12 - Non-Performing Assets and Past Due Loans and Leases

                                         
    September 30,   June 30,   March 31,   December 31,   September 30,
(in thousands)
  2004
  2004
  2004
  2003
  2003
Non-accrual loans and leases
                                       
Commercial and industrial
  $ 27,140     $ 32,044     $ 45,056     $ 43,387     $ 82,413  
Commercial real estate
    19,762       15,782       20,019       22,399       30,545  
Residential mortgage
    13,197       13,952       12,052       9,695       8,923  
Home equity
    7,685                          
 
   
 
     
 
     
 
     
 
     
 
 
Total non-performing loans and leases (NPLs)
    67,784       61,778       77,127       75,481       121,881  
Other real estate, net
    12,692       12,918       14,567       11,905       15,196  
 
   
 
     
 
     
 
     
 
     
 
 
Total Non-performing Assets (NPAs)
  $ 80,476     $ 74,696     $ 91,694     $ 87,386     $ 137,077  
 
   
 
     
 
     
 
     
 
     
 
 
Accruing loans and leases past due 90 days or more
  $ 53,456     $ 51,490     $ 59,697     $ 55,913     $ 66,060  
 
   
 
     
 
     
 
     
 
     
 
 
NPLs as a % of total loans and leases
    0.30 %     0.28 %     0.36 %     0.36 %     0.58 %
NPAs as a % of total loans and leases and other real estate
    0.36       0.34       0.43       0.41       0.65  
Allowance for loan and lease losses as a % of:
                                       
NPLs
    417       464       383       397       276  
NPAs
    351       384       322       343       245  
Allowance for loan and lease losses plus allowance for unfunded commitments and letters of credit:
                                       
NPLs
    461       515       425       444       304  
NPAs
    389       426       357       384       270  
Accruing loans and leases past due 90 days or more to total loans and leases
    0.24       0.24       0.28       0.27       0.31  

44


     NPAs were $80.5 million at September 30, 2004, down $56.6 million, or 41%, from the prior year, and up $5.8 million, or 8%, from June 30, 2004. NPAs as a percent of total loans and leases and other real estate were 0.36% at September 30, 2004, down from 0.65% a year-ago, but up slightly from 0.34% at June 30, 2004. At September 30, 2004, the company adopted a new policy of placing home equity loans and lines on non-accrual status when they exceed 180 days past due. Such loans were previously classified as accruing loans and leases past due 90 days or more. This policy change conforms the home equity loans and lines classification to that of other consumer loans secured by residential real estate. As a result of this change in policy, the current quarter included $7.7 million of non-performing home equity loans and lines secured by real estate. NPAs at September 30, 2004, included $30.2 million of lower-risk residential real estate-related assets, which represented 38% of total NPAs. This compared with $19.1 million, or 14%, at the end of the year-ago quarter.

     The over 90-day delinquent, but still accruing, ratio was 0.24% at September 30, 2004, down from 0.31% a year ago, and unchanged from 0.24% at June 30, 2004.

     Table 13 reflects NPA activity. The $22.7 million of new NPAs in the 2004 third quarter included the addition of the $7.7 million of non-performing home equity loans and lines due to the policy change noted above. Excluding the  
$7.7 million, new NPAs in the third quarter were $15.1 million.

Non-performing Assets Activity

Table 13 — Non-Performing Asset Activity

                                         
    Three Months Ended
    September 30,   June 30,   March 31,   December 31,   September 30,
(in thousands)
  2004
  2004
  2004
  2003
  2003
Beginning of Period
  $ 74,696     $ 91,694     $ 87,386     $ 137,077     $ 133,722  
New non-performing assets
    22,740       25,727       27,208       38,367       52,213  
Returns to accruing status
          (1,493 )     (54 )     (454 )     (319 )
Loans and lease losses
    (5,424 )     (12,872 )     (10,463 )     (39,657 )     (22,090 )
Payments
    (10,202 )     (13,571 )     (10,717 )     (22,710 )     (18,905 )
Sales
    (1,334 )     (14,789 )     (1,666 )     (25,237 )     (7,544 )
 
   
 
     
 
     
 
     
 
     
 
 
End of Period
  $ 80,476     $ 74,696     $ 91,694     $ 87,386     $ 137,077  
 
   
 
     
 
     
 
     
 
     
 
 

45


Allowances for Credit Losses (ACL) and Provision for Credit Losses

     The company maintains two reserves, both of which are available to absorb possible credit losses: the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments (AULC). When summed together, these reserves constitute the total allowances for credit losses (ACL). Table 14  
reflects activity in the ALLL and AULC for the past five quarters:

Table 14 — Allowances for Credit Losses

                                         
    Three Months Ended
    September 30,   June 30,   March 31,   December 31,   September 30,
(in thousands)
  2004
  2004
  2004
  2003
  2003
Allowance for Loan and Lease Losses, Beginning of Period
  $ 286,935     $ 295,377     $ 299,732     $ 336,398     $ 307,667  
Loan and lease losses
    (26,366 )     (30,845 )     (37,167 )     (68,023 )     (43,261 )
Recoveries of loans previously charged off
    9,886       18,330       8,540       12,880       10,487  
 
   
 
     
 
     
 
     
 
     
 
 
Net loan and lease losses
    (16,480 )     (12,515 )     (28,627 )     (55,143 )     (32,774 )
 
   
 
     
 
     
 
     
 
     
 
 
Provision for credit losses
    11,785       5,027       25,596       26,341       51,615  
Net change in allowance for unfunded loan commitments and letters of credit
    1,186       896       3,433       (1,785 )     (457 )
Allowance of assets sold and securitized (1)
    (776 )     (1,850 )     (4,757 )     (6,079 )     10,347  
 
   
 
     
 
     
 
     
 
     
 
 
Allowance for Loan and Lease Losses, End of Period
  $ 282,650     $ 286,935     $ 295,377     $ 299,732     $ 336,398  
 
   
 
     
 
     
 
     
 
     
 
 
Allowance for Unfunded Loan Commitments and Letters of Credit, Beginning of Period
  $ 31,193     $ 32,089     $ 35,522     $ 33,737     $ 33,280  
Net change
    (1,186 )     (896 )     (3,433 )     1,785       457  
 
   
 
     
 
     
 
     
 
     
 
 
Allowance for Unfunded Loan Commitments and Letters of Credit, End of Period
  $ 30,007     $ 31,193     $ 32,089     $ 35,522     $ 33,737  
 
   
 
     
 
     
 
     
 
     
 
 
Total Allowances for Credit Losses
  $ 312,657     $ 318,128     $ 327,466     $ 335,254     $ 370,135  
 
   
 
     
 
     
 
     
 
     
 
 
Allowances for Credit Losses as a % of total loans and leases
    1.38 %     1.46 %     1.55 %     1.59 %     1.75 %
Components of ALLL as a % of total loans and leases:
                                       
Transaction reserve
    0.84 %     0.86 %     0.91 %     0.88 %     0.98 %
Economic reserve
    0.33       0.36       0.38       0.40       0.47  
Specific reserve
    0.08       0.10       0.10       0.14       0.14  
 
   
 
     
 
     
 
     
 
     
 
 
Total
    1.25 %     1.32 %     1.39 %     1.42 %     1.59 %
 
   
 
     
 
     
 
     
 
     
 
 

(1)  The third quarter 2003 includes the allowance for loan losses associated with automobile loans from a securitizations trust that was consolidated as a result of the adoption of FASB Interpretation No. 46 on July 1, 2003.

     The September 30, 2004, ALLL was $282.7 million, down from $336.4 million a year ago and from $286.9 million at June 30, 2004. These declines reflected continued credit quality improvement, the change in the mix of the loan portfolio to lower-risk residential mortgages and home equity loans, and improvement in the economic outlook. Expressed as a percent of period-end loans and leases, the ALLL at September 30, 2004, was 1.25%, down from 1.59% a year-ago and from 1.32% at June 30, 2004. The ALLL as a percent of NPAs was 351% at September 30, 2004, up from 245% a year ago, but down from 384% at June 30, 2004.

     The September 30, 2004, AULC was $30.0 million, down slightly from $33.7 million at the end of the year-ago quarter, and from $31.2 million at June 30, 2004.

     On a combined basis, the ACL as a percent of total loans and leases was 1.38% at September 30, 2004, compared with 1.75% a year ago and 1.46% at the end of last quarter. The ACL as a percent of NPAs was 389% at September 30, 2004, compared with 270% a year earlier and 426% at June 30, 2004.

     The provision for credit losses in the 2004 third quarter was $11.8 million, a $39.8 million reduction from the year-ago quarter, but a $6.8 million increase from the 2004 second quarter. The reduction in provision expense from the year-ago quarter reflected overall improved portfolio quality performance and a stronger economic outlook, only partially offset by provision expense related to loan growth. The increase in provision expense from the second quarter primarily reflected lower recoveries, as the second quarter included a $9.7 million commercial loan recovery. As previously disclosed,

46


effective January 1, 2004, the company adopted a more quantitative approach to calculating the economic reserve component of the ALLL making this component more responsive to changes in economic conditions (see discussion below). This change, combined with the quantitative approach for determining the transaction reserve component, as well as changes to the specific reserve component, may result in more volatility in the total ALLL, and corresponding provision for loan and lease losses.

     The ALLL consists of three components, the transaction reserve, the economic reserve, and specific reserves (see the Credit Risk discussion in company’s 2003 Form 10-K for additional discussion).

Transaction reserve – This ALLL component is based on historical portfolio performance information. Specifically, the probability-of-default and the loss-in-event-of-default are assigned an expected risk factor based on the type and structure of each credit. Reserve factors are then calculated and applied at an individual loan level for all products.

Specific reserves – This ALLL component represents the sum of credit-by-credit reserve decisions for individual C&I and CRE loans when it is determined that the related expected risk factor is insufficient to cover the estimated losses embedded in the specified credit facility.

Economic reserve – This ALLL component reflects anticipated losses impacted by changes in the economic environment. As previously reported, effective January 1, 2004, the company adopted a significantly more quantitative approach to the calculation of the economic reserve component. In order to quantify the economic reserve, the company identified four statistically significant indicators of loss volatility over the seven-year period from 1996 through 2003. The four variables as identified by the regression model are: (1) the US Index of Leading Economic Indicators, (2) the US Corporate Profits Index, (3) the US Unemployment Index, and (4) the University of Michigan Current Consumer Confidence Index.

     This methodology permits the decomposition of the total ALLL ratio into these three components and provides increased insight into the rationale for increases or decreases in the overall ALLL ratio. As shown in Table 14, the ALLL ratio at September 30, 2004 was 1.25%, of which 0.84% represented the transaction reserve, 0.33% the economic reserve, and 0.08% specific reserves. Of the 7 basis point decline in the ALLL ratio from 1.32% at June 30, 2004, the transaction and specific reserves each accounted for 2 basis points of the decline. This reflected the combination of the shift in the loan and lease portfolio mix toward higher credit quality loans, as well as the release of specific reserves due to the improvement in the credit quality and/or the resolution of individual C&I and CRE credit situations. The remaining 3 basis points of decline in the ALLL ratio represented lower relative economic reserves, reflecting an improved economic outlook. This more quantitative methodology for determining the ALLL will be more responsive to changes in the portfolio mix, the economic environment, and individual credit situations, with the result being an ALLL ratio that exhibits greater quarterly fluctuations.

MARKET RISK

     Market risk is the potential for losses in the fair value of the company’s assets and liabilities due to changes in interest rates, exchange rates, and equity prices. The company incurs market risk in the normal course of business. Market risk arises when the company extends fixed-rate loans, purchases fixed-rate securities, originates fixed-rate certificates of deposit (CDs), obtains funding through fixed-rate borrowings, and leases automobiles and equipment based on expected lease residual values. Market risk arising from changes in interest rates, which affects the market values of fixed-rate assets and liabilities, is interest rate risk. Market risk arising from the possibility that the uninsured residual value of leased assets will be different at the end of the lease term than was estimated at the lease’s inception is residual value risk. From time to time, the company also has small exposures to trading risk and foreign exchange risk. At September 30, 2004, the company had $120.3 million of trading assets, primarily in its broker/dealer businesses.

Interest Rate Risk

     Interest rate risk is the primary market risk incurred by the company. It results from timing differences in the repricing and maturity of assets and liabilities and changes in relationships between market interest rates and the yields on assets and rates on liabilities, including the impact of embedded options.

     Management seeks to minimize the impact of changing interest rates on the company’s net interest income and the fair value of assets and liabilities. The board of directors establishes broad policies regarding interest rate and market risk

47


and liquidity risk. The asset and liability committee (ALCO) establishes specific operating limits within the parameters of the board of directors’ policies. ALCO regularly monitors position concentrations and the level of interest rate sensitivity to ensure compliance with board of directors approved risk tolerances (see Interest Rate Risk discussion in the company’s 2003 Form 10-K for a complete discussion).

     Interest rate risk modeling is performed monthly. Two broad approaches to modeling interest rate risk are employed: income simulation and economic value analysis. An income simulation analysis is used to measure the sensitivity of forecasted net interest income to changes in market rates over a one-year horizon. The economic value analysis (Economic Value of Equity or EVE) is calculated by subjecting the period-end balance sheet to changes in interest rates and measuring the impact of the changes in the value of the assets and liabilities.

     The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual 100 and 200 basis point increasing and decreasing parallel shifts in interest rates over the next twelve-month period beyond the interest rate change implied by the current yield curve. The table below shows the results of the scenarios as of September 30, 2004, and June 30, 2004. All  
of the positions were well within the board of directors’ policy limits.

Net Interest Income at Risk (%)

                                 
Basis point change scenario
    -200       -100       +100       +200  
Board Policy Limits
    -4.0 %     -2.0 %     -2.0 %     -4.0 %
     
     
     
     
 
September 30, 2004
    N.M.       -0.5 %     +0.3 %     +0.5 %
June 30, 2004
    N.M.       -0.3 %     -0.0 %     -0.1 %
December 31, 2003
    N.M.       -0.3 %     -0.2 %     -0.5 %
N.M. – Not Meaningful.
                 

     The primary simulations for EVE risk assume an immediate and parallel increase in rates of +/- 100 and +/- 200 basis points beyond any interest rate change implied by the current yield curve. The table below outlines the results  
compared to the previous quarter and policy limits.

Economic Value of Equity at Risk (%)

                                 
Basis point change scenario
    -200       -100       +100       +200  
Board Policy Limits
    -12.0 %     -5.0 %     -5.0 %     -12.0 %
     
     
     
     
 
September 30, 2004
    N.M.       -0.4 %     -1.4 %     -3.9 %
June 30, 2004
    N.M.       +1.5 %     -2.8 %     -6.2 %
December 31, 2003
    N.M.       +1.8 %     -3.5 %     -7.9 %
N.M. – Not Meaningful.
                 

LIQUIDITY RISK

     The objective of effective liquidity management is to ensure that cash flow needs can be met on a timely basis at a reasonable cost under both normal operating conditions and unforeseen or unpredictable circumstances. The liquidity of the Bank is available to originate loans and leases and to repay deposit and other liabilities as they become due or are demanded by customers. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues, investor perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues (see Liquidity discussion in the company’s 2003 Form 10-K for a complete discussion).

     The primary source of funding is core deposits from retail and commercial customers (see Table 15). As of September 30, 2004, core deposits totaled $16.7 billion, and represented 83% of total deposits. This compared with $15.6 billion, or 83% of total deposits, a year earlier. Most of the growth in core deposits was attributable to growth in interest bearing and non-interest bearing demand deposits as retail CDs declined.

48


 

Table 15 - Deposit Liabilities

                                                                                 
    September 30, 2004
  June 30, 2004
  March 31, 2004
  December 31, 2003
  September 30, 2003
(in millions)
  Amount
  %
  Amount
  %
  Amount
  %
  Amount
  %
  Amount
  %
By Type
                                                                               
Demand deposits
 
Non-interest bearing
  $ 3,264       16.2 %   $ 3,327       17.1 %   $ 2,918       15.4 %   $ 2,987       16.2 %   $ 3,003       15.9 %
Interest bearing
    7,472       37.2       7,124       36.6       6,866       36.2       6,411       34.7       6,425       34.1  
Savings deposits
    2,983       14.8       3,011       15.5       3,002       15.8       2,960       16.0       3,000       15.9  
Retail certificates of deposit
    2,441       12.1       2,412       12.4       2,395       12.6       2,462       13.3       2,484       13.2  
Other domestic time deposits
    588       3.0       595       3.1       608       3.2       631       3.4       638       3.4  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Core Deposits
    16,748       83.3       16,470       84.7       15,789       83.2       15,451       83.6       15,550       82.5  
Domestic time deposits of $100,000 or more
    998       5.0       808       4.2       791       4.2       789       4.3       844       4.5  
Brokered time deposits and negotiable CDs
    1,896       9.4       1,679       8.6       1,942       10.2       1,772       9.6       1,837       9.8  
Foreign time deposits
    467       2.3       508       2.5       467       2.4       475       2.5       603       3.2  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Deposits
  $ 20,109       100.0 %   $ 19,465       100.0 %   $ 18,989       100.0 %   $ 18,487       100.0 %   $ 18,834       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
By Business Segment (2)
                                                                               
Central Ohio
  $ 4,400       21.9 %   $ 4,386       22.5 %   $ 4,378       23.1 %   $ 4,184       22.6 %   $ 4,189       22.3 %
Northern Ohio
    4,015       20.0       3,774       19.4       3,517       18.5       3,505       19.0       3,531       18.8  
Southern Ohio/Kentucky
    1,601       8.0       1,559       8.0       1,476       7.8       1,442       7.8       1,437       7.6  
West Michigan
    2,699       13.4       2,599       13.4       2,609       13.7       2,457       13.3       2,529       13.4  
East Michigan
    2,169       10.8       2,081       10.7       2,030       10.7       1,988       10.8       2,000       10.6  
West Virginia
    1,381       6.9       1,369       7.0       1,292       6.8       1,315       7.1       1,324       7.0  
Indiana
    666       3.3       668       3.4       637       3.4       648       3.5       661       3.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Regional Banking
    16,931       84.2       16,435       84.4       15,939       84.0       15,539       84.1       15,671       83.2  
Dealer Sales
    70       0.3       71       0.4       77       0.4       77       0.4       65       0.4  
Private Financial Group
    1,125       5.6       1,016       5.2       1,057       5.6       1,164       6.3       1,117       5.9  
Treasury/Other (1)
    1,983       9.9       1,943       10.0       1,916       10.0       1,707       9.2       1,981       10.5  
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Deposits
  $ 20,109       100.0 %   $ 19,465       100.0 %   $ 18,989       100.0 %   $ 18,487       100.0 %   $ 18,834       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 

(1)   Comprised largely of brokered deposits and negotiable CDs.

(2)   Prior period amounts have been reclassified to conform to the current period business segment structure.

     Liquidity policies and limits are established by the board of directors, with operating limits set by ALCO. Two primary liquidity measures are the ratio of loans and operating lease assets to deposits and the percentage of assets funded with non-core, or wholesale, liabilities. The limits set by the board for these two liquidity measures are 135% and 40%, respectively. At September 30, 2004, the actual ratio of loans and operating leases to deposits was 116%, while the percentage of assets funded with non-core or wholesale liabilities was 35%. In addition, guidelines are established by ALCO to ensure diversification of wholesale funding by type, source, and maturity and provide sufficient balance sheet liquidity to cover 100% of wholesale funds maturing within a six-month time period. A contingency funding plan is in place, which includes forecasted sources and uses of funds under various scenarios in order to prepare for unexpected liquidity shortages, including the implications of any rating agency changes. ALCO meets monthly to identify and monitor liquidity issues, provide policy guidance, and oversee adherence to, and the maintenance of, an evolving contingency funding plan.

     Credit ratings by the three major credit rating agencies are an important component of the company’s liquidity profile. Among other factors, the credit ratings are based on the financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and the company’s ability to access a broad array of wholesale funding sources. Adverse changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital markets, but also the cost of these funds. In addition, certain financial on- and off-balance sheet arrangements contain credit rating triggers that could increase funding needs if a negative rating change occurs. Letter of credit commitments for marketable securities, interest rate swap collateral agreements, and certain asset securitization transactions contain credit rating provisions.

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     As of September 30, 2004, credit ratings are as follows:

 
                 
    Senior            
    Unsecured   Subordinated   Short    
    Notes
  Notes
  Term
  Outlook
Huntington Bancshares Incorporated
               
Moody’s Investor Service (1)
  A2   A3   P1   Negative
Standard and Poor’s
  A-   BBB+   A2   Stable
Fitch Ratings (1)
  A   A-   F1   Negative
The Huntington National Bank
               
Moody’s Investor Service (1)
  A1   A2   P1   Negative
Standard and Poor’s
  A   A-   A1   Stable
Fitch Ratings (1)
  A   A-   F1   Negative

(1)   Following Huntington’s announcement on November 3, 2004, as more fully described in Note 4 to the Unaudited Condensed Consolidated Financial Statements, Fitch Ratings revised their outlook for Huntington to Negative from Stable. Also, Moody’s Investors Service placed all the ratings of Huntington on review for possible downgrade.

     Management believes that sufficient liquidity exists to meet the funding needs of the Bank and the parent company.

OFF-BALANCE SHEET ARRANGEMENTS

     Like other financial organizations, Huntington has various commitments in the ordinary course of business that, under GAAP, are not recorded in the financial statements. Specifically, Huntington makes various commitments to extend credit to customers, to sell loans, and to maintain obligations under operating-type non-cancelable leases for its facilities. Derivatives and other off-balance sheet arrangements are discussed under the “Market Risk” section of the company’s 2003 Form 10-K.

     Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. There were $989 million of outstanding standby letters of credit at September 30, 2004. Non-interest income was recognized from the issuance of these standby letters of credit of $8.5 million for the nine-month period ended September 30, 2004. The carrying amount of deferred revenue related to standby letters of credit at September 30, 2004, was $3.9 million. Standby letters of credit are included in the determination of the amount of risk-based capital that the company and the Bank are required to hold.

CAPITAL

     Capital is managed both at the parent and the Bank levels. Capital levels are maintained based on regulatory capital requirements and the economic capital required to support credit, market, and operation risks inherent in the company’s business and to provide the flexibility needed for future growth and new business opportunities. Management places significant emphasis on the maintenance of a strong capital position, which promotes investor confidence, provides access to the national markets under favorable terms, and enhances business growth and acquisition opportunities. The importance of managing capital is also recognized, and Management continually strives to maintain an appropriate balance between capital adequacy and providing attractive returns to shareholders.

     Shareholders’ equity totaled $2.5 billion at September 30, 2004. This balance represented a $186 million increase from December 31, 2003. The growth in shareholders’ equity resulted from the retention of net income after dividends to shareholders of $181 million and stock option exercises of $18 million. This growth was offset by a decrease in accumulated other comprehensive income of $16 million. The decrease in accumulated other comprehensive income primarily resulted from a decline in the market value of securities available for sale, partially offset by an increase in the market value of cash flow hedges at September 30, 2004, compared with December 31, 2003.

     On September 4, 2001, options totaling 3.2 million shares of common stock were granted to, with certain specified exceptions, full- and part-time employees under the Huntington Bancshares Incorporated Employee Stock Incentive Plan

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(the “Incentive Plan”). Under the terms of the Incentive Plan, these options were to vest on the earlier of September 4, 2006, or at such time as the closing price for Huntington’s common stock for five consecutive trading days reached or exceeded $25.00. Huntington’s common stock closing price exceeded $25.00 for each of the five consecutive trading days beginning October 1, 2004, and ending October 7, 2004. As a result, options for 2.0 million shares of common stock granted under the Incentive Plan, net of options for 1.2 million shares cancelled due to employee attrition, became fully vested and exercisable after the close of trading on October 7, 2004.

     At September 30, 2004, the company had unused authority to repurchase up to 7.5 million shares, though no shares were repurchased during the 2004 third quarter. This authorization may be used to help mitigate the dilutive earnings impact resulting from the issuance of these Incentive Plan shares. All purchases under the current authorization will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions.

     On October 13, 2004, the board of directors declared a quarterly cash dividend on its common stock of $0.20 per common share. The dividend is  
payable January 3, 2005, to shareholders of record on December 17, 2004.

Table 16 - Quarterly Common Stock Summary

                                         
    2004
  2003
    Third   Second   First   Fourth   Third
Common Stock Price
                                       
High (1)
  $ 25.150     $ 23.120     $ 23.780     $ 22.550     $ 20.890  
Low (1)
    22.700       20.890       21.000       19.850       19.220  
Close
    24.910       22.980       22.030       22.500       19.850  
Average closing price
    24.105       22.050       22.501       21.584       20.199  
Book value per share
  $ 10.69     $ 10.40     $ 10.31     $ 9.93     $ 9.79  
Dividends
                                       
Cash dividends declared
  $ 0.200     $ 0.175     $ 0.175     $ 0.175     $ 0.175  
Common shares outstanding (000s)
                                       
Average - Basic
    229,848       229,429       229,227       228,902       228,715  
Average - Diluted
    234,348       232,659       232,915       231,986       230,966  
Ending
    230,153       229,476       229,410       229,008       228,870  
Common Share Repurchase Program (000s)
                                       
Number of Shares Repurchased
                             

(1)   High and low stock prices are intra-day quotes obtained from NASDAQ.

     Average equity to average assets in the 2004 third quarter was 7.66%, up from 7.49% a year earlier, and up from 7.42% for the second quarter of 2004 (see Table 17). At September 30, 2004, the tangible equity to assets ratio was 7.11%, up from 6.77% a year ago, and from 6.95% at June 30, 2004. The increase from June 30, 2004, primarily reflected growth in retained earnings.

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Table 17 - Capital Adequacy

                                         
    Three Months Ended
    September 30   June 30,   March 31   December 31,   September 30,
(in millions)
  2004
  2004
  2004
  2003
  2003
Total Risk-Adjusted Assets
  $ 28,773     $ 28,413     $ 28,236     $ 28,164     $ 27,949  
Tier 1 Risk-Based Capital Ratio
    9.08 %     8.98 %     8.74 %     8.53 %     8.40 %
Total Risk-Based Capital Ratio
    12.50       12.56       12.38       11.95       11.19  
Tier 1 Leverage Ratio
    8.36       8.20       8.08       7.98       7.94  
Tangible Equity / Assets Ratio
    7.11       6.95       6.97       6.79       6.77  
Tangible Equity / Risk-Weighted Assets Ratio
    7.80       7.64       7.61       7.30       7.24  
Average Equity / Average Assets
    7.66       7.42       7.39       7.32       7.49  

     At September 30, 2004, the tangible equity to risk-weighted assets ratio was 7.80%, up significantly from 7.24% in the year-ago quarter, and up from 7.64% at June 30, 2004. The increase in the tangible equity to risk-weighted assets ratio reflected primarily the positive impact resulting from reducing the overall risk profile of earning assets throughout this period, most notably a less risky loan portfolio mix, as well as growth in low risk investment securities.

     The Federal Reserve Board, which supervises and regulates the company, sets minimum capital requirements for each of these regulatory capital ratios. In the calculation of these risk-based capital ratios, risk weightings are assigned to certain asset and off-balance sheet items such as interest rate swaps, loan commitments, and securitizations. Huntington’s Tier 1 Risk-based Capital, Total Risk-based Capital, Tier 1 Leverage ratios, and risk-adjusted assets for the recent five quarters are well in excess of minimum levels established for “well capitalized” institutions of 6.00%, 10.00%, and 5.00%, respectively. At September 30, 2004, the company had regulatory capital ratios in excess of “well capitalized” regulatory minimums.

     The Bank is primarily supervised and regulated by the Office of the Comptroller of the Currency, which establishes regulatory capital guidelines for banks similar to those established for bank holding companies by the Federal Reserve Board. At September 30, 2004, the Bank had regulatory capital ratios in excess of “well capitalized” regulatory minimums.

LINES OF BUSINESS DISCUSSION

     Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes the company’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Lines of business results are determined based upon the company’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around Huntington’s organizational and management structure and, accordingly, the results below are not necessarily comparable with similar information published by other financial institutions. A description of each segment and discussion of financial results is provided below.

     Management uses earnings on an operating basis, rather than on a GAAP basis, to measure underlying performance trends for each business segment. Analyzing earnings on an operating basis is very helpful in assessing underlying performance trends, a critical factor used by Management to determine the success of strategies and future earnings capabilities. Operating earnings represent GAAP earnings adjusted to exclude the impact of the significant items discussed in Note 8 to the Condensed Consolidated Financial Statements.

Regional Banking

     Regional Banking provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 59% and 80% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank— Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including commercial loans, international trade,

52


cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.

2004 Third Quarter versus 2003 Third Quarter

     Regional banking contributed $59.1 million of the company’s net operating earnings in the third quarter of 2004, up $4.0 million, or 7%, from the third quarter of 2003. This increase was due primarily to a $27.5 million reduction in provision for credit losses, which was partially offset by $21.3 million decline in mortgage banking income. Total fully taxable equivalent revenues declined $18.4 million, or 7%, from the third quarter of 2003 due to lower mortgage banking income. Total expenses increased $3.0 million, or 2%, from the year-ago quarter. The ROA was 1.39% in the current quarter, down from 1.45% in the year-ago quarter, though the ROE of 22.4% in the current quarter increased from 21.2% in the year-ago quarter.

     Compared with the year-ago quarter, 2004 third quarter net interest income increased $2.2 million, or 1%, reflecting an 18% increase in average total loans and 5% increase in average total deposits, partially offset by a 43 basis point decline in net interest margin to 4.10% from 4.53%.

     Average total loans increased $2.4 billion, or 18%, primarily reflecting a $1.7 billion increase in average residential mortgages, a $0.5 billion, or 15%, increase in home equity loans and lines of credit, as well as a $0.5 billion, or 12%, increase in average CRE loans. The growth in home equity, residential mortgages, and CRE loans reflected the continued favorable impact of low interest rates on demand for real estate-related financing. Total average C&I loans declined $0.2 billion, or 6%, from the year-ago quarter, due in part to weak demand, as well as the impact from continued strategies to lower exposure to large individual commercial credits, and to a lesser degree, a decline in shared national credits. Small Business C&I and CRE loans (included in total average C&I and CRE loans) increased $0.2 billion, or 11%, due to specific strategies that focus on this business segment.

     Average total deposits increased $0.8 billion, or 5%. This reflected strong growth in average interest bearing demand deposits, up $0.9 billion, or 15%, which was partially offset by a $0.1 billion, or 4%, decline in domestic time deposits. Of the $0.8 billion increase in average total deposits, Commercial Banking accounted for $0.6 billion and Small Business $0.3 billion, which was partially offset by a $0.1 billion decline in average total deposits in Mortgage Banking.

     The company continued its focus on customer service and delivery channel optimization. From the year-ago quarter, six banking offices were opened while three were closed. The number of Retail Banking demand deposit account (DDA) households increased 2% from the end of the year-ago quarter. Progress was made in improving the Retail Banking 90-day cross sell ratio, from 2.0 products or services to 2.3, a 15% improvement. Further, the online banking penetration of retail households with on-line banking increased to 36% from 29% a year earlier, with a 31% increase in the number of online customers.

     The 43 basis points, or an effective 9%, decline in the net interest margin to 4.10% from 4.53% reflected a combination of factors. This included a shift in the loan portfolio mix to lower-margin, but higher credit quality, consumer residential real estate-related loans. In addition, interest rates offered on deposits have been near historical lows throughout this period, and despite rising recently, they remain below levels of a year ago such that it remained difficult to make commensurate reductions in deposit rates compared with reductions in loan yields compared with a year earlier.

     The provision for credit losses for the third quarter of 2004 was $5.1 million or $27.5 million less than in the year-ago quarter. This decline reflected the overall improvement in credit quality including lower NPAs, as well as the shift to lower-rate, lower-risk residential mortgages and home equity loans and lines. Net charge-offs were $7.2 million, or an annualized 0.18% of average loans and leases, down from $19.8 million, or an annualized 0.59%, in the year-ago quarter (see Credit Risk for additional discussion regarding charge-offs and allowance for loan loss reserve methodologies).

     Non-interest income decreased $20.5 million, or 21%, from the year-ago quarter, primarily due to the $21.3 million lower mortgage banking income, partially offset by higher deposit service charges and equipment operating lease income. Mortgage banking income decreased $21.3 million, or 71%, from the year-ago quarter largely reflecting a change in reporting methodology. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the year-ago quarter a $17.8 million recovery of previously recorded MSR temporary impairment was recognized in Regional Banking. The remainder of the decline in mortgage banking income is attributable to lower production and lower gain on loan sales. The increase in equipment operating lease income reflected growth in operating leases, a relatively new business line. Deposit service charges increased $1.8 million, or 4%, reflecting an increase in demand deposit accounts and

53


higher personal NSF and overdraft fees. The $1.4 million, or 11%, decline in other income reflected lower fee sharing revenue from internal partners.

     Non-interest expense increased $3.0 million, or 2%, from the year-ago quarter, reflecting a $5.9 million, or 10%, increase in personnel costs due to higher salaries and benefit expenses, and to a lesser degree an increase in the number of employees. The $3.4 million, or 4%, decrease in other expenses reflected lower marketing, telecommunications, outside services, and transportation expenses, partially offset by higher occupancy.

2004 Third Quarter versus 2004 Second Quarter

     Regional Banking earnings in the 2004 third quarter decreased $1.7 million, or 3%, from the 2004 second quarter. This reflected a $9.0 million increase in the provision or credit losses, an $8.1 million increase in net-interest income, and a $3.6 million decline in non-interest expense, partially offset by a $5.2 million decline in non-interest income. The ROA and ROE in the 2004 third quarter were 1.39% and 22.4%, respectively, down from 1.52% and 23.9% in the 2004 second quarter.

     Net interest income increased $8.1 million, or 5%, from the prior quarter, reflecting 6% growth in average total loans and 2% in average total deposits, partially offset by a decline in the net interest margin to 4.10% from 4.15%.

     Average total loans increased $0.8 billion, or 6%. Consumer loans increased $0.7 billion, or 11%, reflecting strong growth in residential mortgages and home equity loans and lines of credit. Excluding the impact of the $282 million of C&I loans reclassified as CRE loans on June 30, 2004, average C&I loans increased at a 15% annualized rate during the quarter, with average CRE loans decreasing at a 5% annualized rate. Total average deposits increased $0.4 billion, or 2%, reflecting growth in interest bearing and non-interest bearing demand deposits, up 3% and 2%, respectively, and a 3% increase in domestic time deposits.

     From the end of the 2004 second quarter, the number of DDA households increased an annualized 6%, and the 90-day cross sell ratio increased to 2.34 products from 2.17 products. On-line banking penetration of retail households increased to 36%, and the number of active online users increased 7%.

     The $9.0 million increase in provision for credit losses from the second quarter was primarily due to a $9.7 million recovery on a single C&I credit in the second quarter. Net charge offs were $7.2 million, or an annualized 0.18% of average loans and leases in the current quarter. This was up from $1.8 million, or 0.05%, in the second quarter, as the second quarter net charge-offs were reduced by the $9.7 million C&I recovery.

     Non-interest expense declined $3.6 million, or 2%, from the second quarter of 2004 . This reflected a $7.9 million decline in other expense as the second quarter included $5.8 million of costs related to investments in partnerships generating tax benefits for the first half of 2004. Personnel costs increased $4.1 million impacted by severance costs related to the 2% decline in full-time equivalent employees and lower deferred salary costs associated with lower loan production.

2004 First Nine Months versus 2003 First Nine Months

     Regional banking contributed $167.9 million of the company’s net operating earnings in the first nine months of 2004, up $52.7 million from the comparable year-ago period. This increase reflected the benefits of a $93.4 million reduction in provision for credit losses, and an $11.5 million increase in net interest income, partially offset by a $14.5 million increase in non-interest expense and a $9.4 million decline in non-interest income. The ROA and ROE for first nine months of 2004 were 1.40% and 21.9%, respectively, up from 1.06% and 15.2%, respectively, in the year-ago period.

     Net interest income in the first nine months of 2004 increased $11.5 million, or 3%, reflecting a 14% increase in average total loans and leases and a 5% increase in average total deposits, partially offset by a 32 basis point decline in net interest margin to 4.16% from 4.48%.

     Average total loans increased $1.8 billion, or 14%, primarily reflecting a $1.3 billion, or 83%, increase in average residential mortgages, a $0.5 billion, or 15%, increase in home equity loans and lines of credit, as well as a $0.4 billion, or 12%, increase in average CRE loans. Total average C&I loans declined $0.3 million, or 7%, from the year-ago nine-month period. The growth in home equity, residential mortgages, and CRE loans, as well as the decline in C&I loans reflected the same factors noted above in the year-ago quarter comparison. Small Business C&I and CRE loans (included in total average C&I and CRE loans) increased $0.2 billion, or 11%, due to specific strategies that focus on this business segment.

54


     Average total deposits increased $0.7 billion, or 5%. This reflected strong growth in average interest bearing demand deposits, up $0.9 billion, or 17%, partially offset by a $0.4 billion, or 10%, decline in domestic time deposits. Of the $0.7 billion increase in average total deposits, Corporate Banking accounted for $0.6 billion and Small Business $0.3 billion, with this benefit partially offset by a $0.2 billion decline in average total Retail Banking deposits.

     The 32 basis points, or an effective 7%, decline in the net interest margin to 4.16% from 4.48% reflected the same factors discussed above in the 2004 third quarter versus 2003 third quarter performance.

     Provision for credit losses for the first nine months of 2004 was $3.2 million, down $93.4 million from the year-ago period reflecting the overall improvement in credit quality, as well as the shift to lower risk residential mortgages and home equity loans and lines. Net charge-offs for the first nine months were $20.6 million, or an annualized 0.19% of average loans and leases, down from $71.7 million, or 0.73%, in the comparable year-ago period. The first nine months of 2004 net charge-offs were reduced by a $9.7 million C&I recovery in the second quarter on a single credit that had been charged-off in the fourth quarter of 2002 (see Credit Risk for additional discussion regarding charge-offs and allowance for loan loss reserve methodologies).

     Non-interest income for the first nine months of 2004 decreased $9.4 million, or 4%, from the comparable year-ago period, reflecting a combination of factors including declines in mortgage banking revenue and other income, partially offset by increases in service charges on deposit accounts, and higher other income.

     Non-interest expense for the first nine months of 2004 increased $14.5 million, or 3%, from the year-ago period. This reflected an $11.6 million, or 6%, increase in personnel expenses for the same reasons noted above in the prior year quarter comparison. The $2.0 million, or 1%, increase in other expenses reflected higher occupancy, depreciation, and charge card processing expenses.

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Table 18 - Regional Banking

                                                                         
    2004
  2004
  2003
  3Q04 vs. 3Q03
  2004
  2003
  2004 vs. 2003
    Third
  Second
  Third
  Amount
  %
  9 Months
  9 Months
  Amount
  %
INCOME STATEMENT (in thousands)
                                                                       
Net Interest Income
  $ 163,147     $ 155,083     $ 160,973     $ 2,174       1.4 %   $ 469,292     $ 457,805     $ 11,487       2.5 %
Provision for credit losses
    5,086       (3,949 )     32,537       (27,451 )     -84.4 %     3,242       96,615       (93,373 )     -96.6 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Net Interest Income After Provision for Credit Losses
    158,061       159,032       128,436       29,625       23.1 %     466,050       361,190       104,860       29.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Operating lease income
    584       327             584     NM     960             960     NM
Service charges on deposit accounts
    42,923       42,357       41,151       1,772       4.3 %     125,983       119,522       6,461       5.4 %
Brokerage and insurance income
    3,615       4,515       4,199       (584 )     -13.9 %     11,986       12,042       (56 )     -0.5 %
Trust services
    263       225       200       63       31.5 %     780       748       32       4.3 %
Mortgage banking
    8,588       13,227       29,880       (21,292 )     -71.3 %     27,848       47,821       (19,973 )     -41.8 %
Other service charges and fees
    10,685       10,529       10,401       284       2.7 %     30,627       31,900       (1,273 )     -4.0 %
Other
    10,584       11,295       11,941       (1,357 )     -11.4 %     33,584       29,128       4,456       15.3 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Non-Interest Income Before Securities Gains
    77,242       82,475       97,772       (20,530 )     -21.0 %     231,768       241,161       (9,393 )     -3.9 %
Securities gains
    14                   14     NM     14             14     NM
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Non-Interest Income
    77,256       82,475       97,772       (20,516 )     -21.0 %     231,782       241,161       (9,379 )     -3.9 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Operating lease expense
    492       275             492     NM     811             811     NM
Personnel costs
    65,859       61,728       59,917       5,942       9.9 %     190,743       179,110       11,633       6.5 %
Other
    78,072       85,997       81,505       (3,433 )     -4.2 %     247,961       245,935       2,026       0.8 %